Unpleasant Surprises Could Be In Store For Huaiji Dengyun Auto-parts (Holding) Co.,Ltd.'s (SZSE:002715) Shares

Huaiji Dengyun Auto-parts (Holding) Co.,Ltd.'s (SZSE:002715) price-to-sales (or "P/S") ratio of 4.5x may not look like an appealing investment opportunity when you consider close to half the companies in the Auto Components industry in China have P/S ratios below 3x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Huaiji Dengyun Auto-parts (Holding)Ltd

What Does Huaiji Dengyun Auto-parts (Holding)Ltd's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Huaiji Dengyun Auto-parts (Holding)Ltd 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.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Huaiji Dengyun Auto-parts (Holding)Ltd will help you shine a light on its historical performance.

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

There's an inherent assumption that a company should outperform the industry for P/S ratios like Huaiji Dengyun Auto-parts (Holding)Ltd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 5.4% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 18% overall rise in revenue. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable 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 in mind, we find it worrying that Huaiji Dengyun Auto-parts (Holding)Ltd'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. 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.

The Bottom Line On Huaiji Dengyun Auto-parts (Holding)Ltd's P/S

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.

The fact that Huaiji Dengyun Auto-parts (Holding)Ltd 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 observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. 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.

It is also worth noting that we have found 1 warning sign for Huaiji Dengyun Auto-parts (Holding)Ltd that you need to take into consideration.

If these risks are making you reconsider your opinion on Huaiji Dengyun Auto-parts (Holding)Ltd, 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.