Some Confidence Is Lacking In Northeast Electric Development Company Limited's (HKG:42) P/S

When close to half the companies in the Electrical industry in Hong Kong have price-to-sales ratios (or "P/S") below 0.4x, you may consider Northeast Electric Development Company Limited (HKG:42) as a stock to potentially avoid with its 1x 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 as high as it is.

View our latest analysis for Northeast Electric Development

How Northeast Electric Development Has Been Performing

Northeast Electric Development has been doing a good job lately as it's been growing revenue at a solid pace. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Northeast Electric Development's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered an exceptional 29% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 73% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

It's interesting to note that the rest of the industry is similarly expected to grow by 22% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this in mind, we find it intriguing that Northeast Electric Development's P/S exceeds that of its industry peers. Apparently many investors in the company are more bullish than recent times would indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as a continuation of recent revenue trends would weigh down the share price eventually.

The Bottom Line On Northeast Electric Development's P/S

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We didn't expect to see Northeast Electric Development trade at such a high P/S considering its last three-year revenue growth has only been on par with the rest of the industry. When we see average revenue with industry-like growth combined with a high P/S, we suspect the share price is at risk of declining, bringing the P/S back in line with the industry too. Unless there is a significant improvement in the company's medium-term trends, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Having said that, be aware Northeast Electric Development is showing 2 warning signs in our investment analysis, and 1 of those is potentially serious.

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.