SEC Electric Machinery Co., Ltd.'s (SHSE:603988) 42% Share Price Surge Not Quite Adding Up

Despite an already strong run, SEC Electric Machinery Co., Ltd. (SHSE:603988) shares have been powering on, with a gain of 42% in the last thirty days. The last 30 days bring the annual gain to a very sharp 44%.

Following the firm bounce in price, given around half the companies in China's Electrical industry have price-to-sales ratios (or "P/S") below 1.9x, you may consider SEC Electric Machinery as a stock to avoid entirely with its 5.1x 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.

Check out our latest analysis for SEC Electric Machinery

What Does SEC Electric Machinery's P/S Mean For Shareholders?

For instance, SEC Electric Machinery's receding revenue in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for SEC Electric Machinery, 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?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like SEC Electric Machinery's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 20%. As a result, revenue from three years ago have also fallen 23% 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 23% shows it's an unpleasant look.

In light of this, it's alarming that SEC Electric Machinery's P/S sits above the majority of other companies. 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 Bottom Line On SEC Electric Machinery's P/S

SEC Electric Machinery's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that SEC Electric Machinery currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with SEC Electric Machinery (at least 2 which are a bit concerning), and understanding them should be part of your investment process.

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.