Zhejiang Jindun Fans Co., Ltd (SZSE:300411) shareholders would be excited to see that the share price has had a great month, posting a 200% gain and recovering from prior weakness. The last month tops off a massive increase of 129% in the last year.

After such a large jump in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.8x, you may consider Zhejiang Jindun Fans as a stock not worth researching with its 14.7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Zhejiang Jindun Fans' P/S Mean For Shareholders?

For example, consider that Zhejiang Jindun Fans' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Zhejiang Jindun Fans?

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

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 2.2%. This means it has also seen a slide in revenue over the longer-term as revenue is down 34% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 27% shows it's an unpleasant look.

In light of this, it's alarming that Zhejiang Jindun Fans' 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 Key Takeaway

Zhejiang Jindun Fans' P/S has grown nicely over the last month thanks to a handy boost in the share price. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Zhejiang Jindun Fans currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Zhejiang Jindun Fans, and understanding should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.