It's not a stretch to say that Capitalonline Data Service Co., Ltd.'s (SZSE:300846) price-to-sales (or "P/S") ratio of 4.7x right now seems quite "middle-of-the-road" for companies in the IT industry in China, where the median P/S ratio is around 4.5x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

How Has Capitalonline Data Service Performed Recently?

Capitalonline Data Service has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting future revenue performance to only keep up with the broader industry, which has keeping the P/S in line with expectations. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

What Are Revenue Growth Metrics Telling Us About The P/S?

In order to justify its P/S ratio, Capitalonline Data Service would need to produce growth that's similar to the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 21%. Revenue has also lifted 22% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 18% shows it's noticeably less attractive.

With this in mind, we find it intriguing that Capitalonline Data Service's P/S is comparable to that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent revenue trends is likely to weigh down the shares eventually.

What Does Capitalonline Data Service's P/S Mean For Investors?

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Capitalonline Data Service's average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. Right now we are uncomfortable with the P/S as this revenue performance isn't likely to support a more positive sentiment for long. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 3 warning signs for Capitalonline Data Service you should be aware of, and 2 of them make us uncomfortable.

If you're unsure about the strength of Capitalonline Data Service's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.