SMS Electric Co.,Ltd.Zhengzhou's (SZSE:002857) 33% Price Boost Is Out Of Tune With Revenues

SMS Electric Co.,Ltd.Zhengzhou (SZSE:002857) shareholders would be excited to see that the share price has had a great month, posting a 33% 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 28% over that time.

After such a large jump in price, given around half the companies in China's Electronic industry have price-to-sales ratios (or "P/S") below 3.5x, you may consider SMS ElectricLtd.Zhengzhou 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.

Check out our latest analysis for SMS ElectricLtd.Zhengzhou

How SMS ElectricLtd.Zhengzhou Has Been Performing

Recent times have been quite advantageous for SMS ElectricLtd.Zhengzhou as its revenue has been rising very briskly. 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. If not, then existing shareholders might 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 SMS ElectricLtd.Zhengzhou's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as SMS ElectricLtd.Zhengzhou's is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that the company grew revenue by an impressive 68% last year. Pleasingly, revenue has also lifted 55% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

This is in contrast to the rest of the industry, which is expected to grow by 25% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that SMS ElectricLtd.Zhengzhou is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On SMS ElectricLtd.Zhengzhou's P/S

Shares in SMS ElectricLtd.Zhengzhou 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.

The fact that SMS ElectricLtd.Zhengzhou 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

And what about other risks? Every company has them, and we've spotted 4 warning signs for SMS ElectricLtd.Zhengzhou (of which 2 make us uncomfortable!) you should know about.

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.

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