Those holding Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) shares would be relieved that the share price has rebounded 29% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

Although its price has surged higher, Shenzhen Deren Electronic may still look like a strong buying opportunity at present with its price-to-sales (or "P/S") ratio of 0.7x, considering almost half of all companies in the Electronic industry in China have P/S ratios greater than 3.9x and even P/S higher than 8x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so limited.

How Has Shenzhen Deren Electronic Performed Recently?

For example, consider that Shenzhen Deren Electronic's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. Those who are bullish on Shenzhen Deren Electronic will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

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

There's an inherent assumption that a company should far underperform the industry for P/S ratios like Shenzhen Deren Electronic's to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 8.1%. This means it has also seen a slide in revenue over the longer-term as revenue is down 3.9% in total over the last three years. 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.

In light of this, it's understandable that Shenzhen Deren Electronic's P/S would sit below the majority of other companies. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Key Takeaway

Even after such a strong price move, Shenzhen Deren Electronic's P/S still trails the rest of the industry. 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.

As we suspected, our examination of Shenzhen Deren Electronic revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Shenzhen Deren Electronic (of which 2 don't sit too well with us!) 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.