Risks To Shareholder Returns Are Elevated At These Prices For Weihai Huadong Automation Co., Ltd (SZSE:002248)

Weihai Huadong Automation Co., Ltd's (SZSE:002248) price-to-sales (or "P/S") ratio of 6.3x may look like a poor investment opportunity when you consider close to half the companies in the Machinery industry in China 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 highly elevated P/S.

See our latest analysis for Weihai Huadong Automation

What Does Weihai Huadong Automation's Recent Performance Look Like?

We'd have to say that with no tangible growth over the last year, Weihai Huadong Automation's revenue has been unimpressive. It might be that many are expecting an improvement to the uninspiring revenue performance over the coming period, which has kept the P/S from collapsing. 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 Weihai Huadong Automation will help you shine a light on its historical performance.

Is There Enough Revenue Growth Forecasted For Weihai Huadong Automation?

In order to justify its P/S ratio, Weihai Huadong Automation would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. However, a few strong years before that means that it was still able to grow revenue by an impressive 37% in total over the last three years. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 22% shows it's noticeably less attractive.

With this in mind, we find it worrying that Weihai Huadong Automation'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 Key Takeaway

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 Weihai Huadong Automation 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Weihai Huadong Automation (of which 2 are a bit concerning!) you should know about.

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.