Despite an already strong run, Baotou Huazi Industry Co., Ltd (SHSE:600191) shares have been powering on, with a gain of 32% in the last thirty days. The last 30 days bring the annual gain to a very sharp 46%.

Since its price has surged higher, you could be forgiven for thinking Baotou Huazi Industry is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.4x, considering almost half the companies in China's Food industry have P/S ratios below 1.7x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Baotou Huazi Industry's Recent Performance Look Like?

For example, consider that Baotou Huazi Industry'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?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Baotou Huazi Industry's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 5.5%. In spite of this, the company still managed to deliver immense revenue growth over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company, but investors will want to ask why it is now in decline.

This is in contrast to the rest of the industry, which is expected to grow by 14% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Baotou Huazi Industry's P/S sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the wider industry.

The Key Takeaway

Shares in Baotou Huazi Industry have seen a strong upwards swing lately, which has really helped boost its P/S figure. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

It's no surprise that Baotou Huazi Industry can support its high P/S given the strong revenue growth its experienced over the last three-year is superior to the current industry outlook. At this stage investors feel the potential continued revenue growth in the future is great enough to warrant an inflated P/S. If recent medium-term revenue trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

It is also worth noting that we have found 1 warning sign for Baotou Huazi Industry that you need to take into consideration.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.