Jinlihua Electric Co., Ltd.'s (SZSE:300069) 26% Share Price Surge Not Quite Adding Up

Despite an already strong run, Jinlihua Electric Co., Ltd. (SZSE:300069) shares have been powering on, with a gain of 26% in the last thirty days. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.6% over the last year.

Since its price has surged higher, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.8x, you may consider Jinlihua Electric as a stock not worth researching with its 8.2x 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.

View our latest analysis for Jinlihua Electric

How Jinlihua Electric Has Been Performing

With revenue growth that's exceedingly strong of late, Jinlihua Electric has been doing very well. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Although there are no analyst estimates available for Jinlihua Electric, 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?

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

If we review the last year of revenue growth, the company posted a terrific increase of 47%. The latest three year period has also seen an excellent 49% overall rise in revenue, aided by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 23% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Jinlihua Electric'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. 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

The strong share price surge has lead to Jinlihua Electric's P/S soaring as well. 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.

The fact that Jinlihua Electric 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.

Plus, you should also learn about these 2 warning signs we've spotted with Jinlihua Electric (including 1 which doesn't sit too well with us).

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.