Tanac Automation Co., Ltd.'s (SZSE:300461) Shares May Have Run Too Fast Too Soon

When you see that almost half of the companies in the Machinery industry in China have price-to-sales ratios (or "P/S") below 2.8x, Tanac Automation Co., Ltd. (SZSE:300461) looks to be giving off strong sell signals with its 13.5x 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.

Check out our latest analysis for Tanac Automation

How Has Tanac Automation Performed Recently?

Tanac Automation has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. However, if this isn't the case, investors might get caught out paying too much for the stock.

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 Tanac Automation's earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Tanac Automation?

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

Retrospectively, the last year delivered an exceptional 16% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 33% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Tanac Automation's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Bottom Line On Tanac Automation's P/S

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 Tanac Automation currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Tanac Automation that you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.