When you see that almost half of the companies in the Commercial Services industry in China have price-to-sales ratios (or "P/S") below 2.7x, Shenzhen Water Planning & Design Institute Co., Ltd. (SZSE:301038) looks to be giving off some sell signals with its 3.7x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Has Shenzhen Water Planning & Design Institute Performed Recently?

For instance, Shenzhen Water Planning & Design Institute's receding revenue in recent times would have to be some food for thought. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Shenzhen Water Planning & Design Institute would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered a frustrating 24% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 20% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 30% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Shenzhen Water Planning & Design Institute's P/S exceeds that of its industry peers. 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 Bottom Line On Shenzhen Water Planning & Design Institute's P/S

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.

We've established that Shenzhen Water Planning & Design Institute currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

You need to take note of risks, for example - Shenzhen Water Planning & Design Institute has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.