Letong Chemical Co.,LTD (SZSE:002319) shareholders would be excited to see that the share price has had a great month, posting a 36% gain and recovering from prior weakness. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 6.2% in the last twelve months.

Following the firm bounce in price, when almost half of the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.1x, you may consider Letong ChemicalLTD as a stock not worth researching with its 7.1x 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 Letong ChemicalLTD's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Letong ChemicalLTD over the last year, which is not ideal at all. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Letong ChemicalLTD'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 3.2%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 24% in total. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Letong ChemicalLTD'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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What Does Letong ChemicalLTD's P/S Mean For Investors?

Letong ChemicalLTD's 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.

The fact that Letong ChemicalLTD 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 1 warning sign for Letong ChemicalLTD you should be aware of.

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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