The Huaiji Dengyun Auto-parts (Holding) Co.,Ltd. (SZSE:002715) share price has softened a substantial 29% over the previous 30 days, handing back much of the gains the stock has made lately. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 13%.

Even after such a large drop in price, when almost half of the companies in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.3x, you may still consider Huaiji Dengyun Auto-parts (Holding)Ltd as a stock probably not worth researching with its 3.6x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Has Huaiji Dengyun Auto-parts (Holding)Ltd Performed Recently?

Revenue has risen at a steady rate over the last year for Huaiji Dengyun Auto-parts (Holding)Ltd, which is generally not a bad outcome. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Huaiji Dengyun Auto-parts (Holding)Ltd's Revenue Growth Trending?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Huaiji Dengyun Auto-parts (Holding)Ltd's to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 4.7% last year. Pleasingly, revenue has also lifted 33% in aggregate from three years ago, partly 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.

In light of this, it's alarming that Huaiji Dengyun Auto-parts (Holding)Ltd's P/S sits above the majority of other companies. 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 Huaiji Dengyun Auto-parts (Holding)Ltd's P/S

Huaiji Dengyun Auto-parts (Holding)Ltd's P/S remain high even after its stock plunged. 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.

The fact that Huaiji Dengyun Auto-parts (Holding)Ltd 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Huaiji Dengyun Auto-parts (Holding)Ltd, and understanding should be part of your investment process.

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.

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