More Unpleasant Surprises Could Be In Store For Jiangsu NanFang Precision Co.,Ltd.'s (SZSE:002553) Shares After Tumbling 25%

The Jiangsu NanFang Precision Co.,Ltd. (SZSE:002553) share price has softened a substantial 25% over the previous 30 days, handing back much of the gains the stock has made lately. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

In spite of the heavy fall 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 still consider Jiangsu NanFang PrecisionLtd as a stock to avoid entirely with its 5.6x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

See our latest analysis for Jiangsu NanFang PrecisionLtd

What Does Jiangsu NanFang PrecisionLtd's P/S Mean For Shareholders?

The revenue growth achieved at Jiangsu NanFang PrecisionLtd over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

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 Jiangsu NanFang PrecisionLtd's earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 14% last year. Revenue has also lifted 26% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good 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 momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Jiangsu NanFang PrecisionLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates 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

Even after such a strong price drop, Jiangsu NanFang PrecisionLtd's P/S still exceeds the industry median significantly. 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.

Our examination of Jiangsu NanFang PrecisionLtd revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You need to take note of risks, for example - Jiangsu NanFang PrecisionLtd has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.