What Shanghai STEP Electric Corporation's (SZSE:002527) 42% Share Price Gain Is Not Telling You

Shanghai STEP Electric Corporation (SZSE:002527) shares have had a really impressive month, gaining 42% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 56% in the last year.

Even after such a large jump in price, there still wouldn't be many who think Shanghai STEP Electric's price-to-sales (or "P/S") ratio of 3.1x is worth a mention when the median P/S in China's Machinery industry is similar at about 3.6x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

See our latest analysis for Shanghai STEP Electric

How Shanghai STEP Electric Has Been Performing

For instance, Shanghai STEP Electric's receding revenue in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

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 Shanghai STEP Electric's earnings, revenue and cash flow.

Do Revenue Forecasts Match The P/S Ratio?

In order to justify its P/S ratio, Shanghai STEP Electric would need to produce growth that's similar to the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 6.3%. This means it has also seen a slide in revenue over the longer-term as revenue is down 27% 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.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 23% shows it's an unpleasant look.

With this information, we find it concerning that Shanghai STEP Electric is trading at a fairly similar P/S compared to the industry. 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 on the share price eventually.

What Does Shanghai STEP Electric's P/S Mean For Investors?

Shanghai STEP Electric's stock has a lot of momentum behind it lately, which has brought its P/S level with the rest of the industry. 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.

The fact that Shanghai STEP Electric currently trades at a P/S on par with the rest of the industry is surprising to us since its recent revenues have been in decline over the medium-term, all while the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Shanghai STEP Electric that you need to be mindful of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.