When close to half the companies in the Electrical industry in China have price-to-sales ratios (or "P/S") below 2.4x, you may consider Shenzhen VAPEL Power Supply Technology Co., Ltd. (SZSE:301516) as a stock to avoid entirely with its 6.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Shenzhen VAPEL Power Supply Technology's P/S Mean For Shareholders?

For example, consider that Shenzhen VAPEL Power Supply Technology's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

Shenzhen VAPEL Power Supply Technology's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a frustrating 29% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 37% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Shenzhen VAPEL Power Supply Technology is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Shenzhen VAPEL Power Supply Technology revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Shenzhen VAPEL Power Supply Technology is showing 3 warning signs in our investment analysis, and 2 of those don't sit too well with us.

If these risks are making you reconsider your opinion on Shenzhen VAPEL Power Supply Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.