Guangzhou Tongda Auto Electric Co., Ltd's (SHSE:603390) Shares Climb 27% But Its Business Is Yet to Catch Up

Guangzhou Tongda Auto Electric Co., Ltd (SHSE:603390) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 91%.

Since its price has surged higher, given around half the companies in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.7x, you may consider Guangzhou Tongda Auto Electric as a stock to avoid entirely with its 6.4x P/S ratio. 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.

Check out our latest analysis for Guangzhou Tongda Auto Electric

What Does Guangzhou Tongda Auto Electric's P/S Mean For Shareholders?

The revenue growth achieved at Guangzhou Tongda Auto Electric over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Although there are no analyst estimates available for Guangzhou Tongda Auto Electric, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

Guangzhou Tongda Auto Electric'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 decent 11% gain to the company's revenues. However, due to its less than impressive performance prior to this period, revenue growth is practically non-existent over the last three years overall. Therefore, it's fair to say that revenue growth has been inconsistent recently for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 25% shows it's noticeably less attractive.

With this information, we find it concerning that Guangzhou Tongda Auto Electric 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What We Can Learn From Guangzhou Tongda Auto Electric's P/S?

The strong share price surge has lead to Guangzhou Tongda Auto Electric's P/S soaring as well. 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.

The fact that Guangzhou Tongda Auto Electric currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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.

You should always think about risks. Case in point, we've spotted 2 warning signs for Guangzhou Tongda Auto Electric you should be aware of, and 1 of them is a bit concerning.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.