There's Reason For Concern Over Tanac Automation Co., Ltd.'s (SZSE:300461) Massive 32% Price Jump

Tanac Automation Co., Ltd. (SZSE:300461) shareholders would be excited to see that the share price has had a great month, posting a 32% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 26% over that time.

After such a large jump in price, you could be forgiven for thinking Tanac Automation is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 11.6x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.5x. 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 Tanac Automation

How Has Tanac Automation Performed Recently?

The revenue growth achieved at Tanac Automation over the last year would be more than acceptable for most companies. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. 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 Tanac Automation, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Tanac Automation?

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

If we review the last year of revenue growth, the company posted a terrific increase of 19%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 39% drop in revenue in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 22% shows it's an unpleasant look.

In light of this, it's alarming that Tanac Automation's P/S sits above the majority of other companies. 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 Final Word

Tanac Automation's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Tanac Automation revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

You always need to take note of risks, for example - Tanac Automation has 2 warning signs we think you should be aware 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com