Shanghai Welltech Automation Co.,Ltd.'s (SZSE:002058) Shares Climb 32% But Its Business Is Yet to Catch Up

Shanghai Welltech Automation Co.,Ltd. (SZSE:002058) shares have had a really impressive month, gaining 32% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

Following the firm bounce in price, Shanghai Welltech AutomationLtd may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 11.3x, since almost half of all companies in the Electronic industry in China have P/S ratios under 4.4x and even P/S lower than 2x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Shanghai Welltech AutomationLtd

How Shanghai Welltech AutomationLtd Has Been Performing

The revenue growth achieved at Shanghai Welltech AutomationLtd 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. 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 Shanghai Welltech AutomationLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

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

Taking a look back first, we see that the company managed to grow revenues by a handy 15% last year. Still, lamentably revenue has fallen 39% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Shanghai Welltech AutomationLtd is trading at a P/S higher than 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 heavily on the share price eventually.

The Bottom Line On Shanghai Welltech AutomationLtd's P/S

Shares in Shanghai Welltech AutomationLtd have seen a strong upwards swing lately, which has really helped boost its P/S figure. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Shanghai Welltech AutomationLtd 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Before you take the next step, you should know about the 2 warning signs for Shanghai Welltech AutomationLtd that we have uncovered.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.