What Aurora Optoelectronics Co.,Ltd.'s (SHSE:600666) 40% Share Price Gain Is Not Telling You

Aurora Optoelectronics Co.,Ltd. (SHSE:600666) shareholders would be excited to see that the share price has had a great month, posting a 40% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 88% in the last year.

After such a large jump in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.5x, you may consider Aurora OptoelectronicsLtd as a stock to avoid entirely with its 22.7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Aurora OptoelectronicsLtd

How Has Aurora OptoelectronicsLtd Performed Recently?

Aurora OptoelectronicsLtd has been doing a decent job lately as it's been growing revenue at a reasonable pace. One possibility is that the P/S ratio is high because investors think this good revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Aurora OptoelectronicsLtd's earnings, revenue and cash flow.

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 Aurora OptoelectronicsLtd's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 3.9%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 39% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Aurora OptoelectronicsLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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

Aurora OptoelectronicsLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Aurora OptoelectronicsLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Aurora OptoelectronicsLtd (1 can't be ignored) you should be aware of.

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.