Some Confidence Is Lacking In Zhejiang Yueling Co., Ltd. (SZSE:002725) As Shares Slide 25%

Zhejiang Yueling Co., Ltd. (SZSE:002725) shares have retraced a considerable 25% in the last month, reversing a fair amount of their solid recent performance. The recent drop has obliterated the annual return, with the share price now down 7.3% over that longer period.

Although its price has dipped substantially, you could still be forgiven for thinking Zhejiang Yueling is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.9x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2.2x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

View our latest analysis for Zhejiang Yueling

How Has Zhejiang Yueling Performed Recently?

For example, consider that Zhejiang Yueling'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. However, if this isn't the case, investors might get caught out paying too much for the stock.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Zhejiang Yueling's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as Zhejiang Yueling's is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered a frustrating 1.0% decrease to the company's top line. As a result, revenue from three years ago have also fallen 28% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 24% shows it's an unpleasant look.

With this in mind, we find it worrying that Zhejiang Yueling'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

There's still some elevation in Zhejiang Yueling's P/S, even if the same can't be said for its share price recently. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Zhejiang Yueling 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

You should always think about risks. Case in point, we've spotted 2 warning signs for Zhejiang Yueling you should be aware of, and 1 of them is concerning.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.