Zotye Automobile Co., Ltd (SZSE:000980) shares have had a horrible month, losing 27% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 23% in that time.

In spite of the heavy fall in price, you could still be forgiven for thinking Zotye Automobile is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 18.4x, considering almost half the companies in China's Auto industry have P/S ratios below 1.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Zotye Automobile Performed Recently?

As an illustration, revenue has deteriorated at Zotye Automobile over the last year, which is not ideal at all. 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.

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

The only time you'd be truly comfortable seeing a P/S as steep as Zotye Automobile's is when the company's growth is on track to outshine the industry decidedly.

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 39% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 31% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Zotye Automobile's P/S exceeds that of its industry peers. 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 Final Word

Zotye Automobile's shares may have suffered, but its P/S remains high. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zotye Automobile currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Zotye Automobile that you should be aware of.

If you're unsure about the strength of Zotye Automobile'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.