Xiamen XGMA Machinery Company Limited's (SHSE:600815) 27% Share Price Surge Not Quite Adding Up

Xiamen XGMA Machinery Company Limited (SHSE:600815) shares have had a really impressive month, gaining 27% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 10% is also fairly reasonable.

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 2.8x, you may consider Xiamen XGMA Machinery as a stock to avoid entirely with its 6.2x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Xiamen XGMA Machinery

What Does Xiamen XGMA Machinery's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Xiamen XGMA Machinery over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Xiamen XGMA Machinery will help you shine a light on its historical performance.

How Is Xiamen XGMA Machinery's Revenue Growth Trending?

Xiamen XGMA Machinery'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 frustrating 26% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 49% in aggregate. 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 25% shows it's an unpleasant look.

In light of this, it's alarming that Xiamen XGMA Machinery'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.

What We Can Learn From Xiamen XGMA Machinery's P/S?

The strong share price surge has lead to Xiamen XGMA Machinery's P/S soaring as well. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Xiamen XGMA Machinery 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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Xiamen XGMA Machinery that you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.