Tongyu Communication Inc. (SZSE:002792) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 18% is also fairly reasonable.

After such a large jump in price, Tongyu Communication may be sending bearish signals at the moment with its price-to-sales (or "P/S") ratio of 6.3x, since almost half of all companies in the Communications in China have P/S ratios under 4.4x and even P/S lower than 2x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Tongyu Communication Has Been Performing

For instance, Tongyu Communication'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

Tongyu Communication's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Retrospectively, the last year delivered a frustrating 8.0% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 24% 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 50% 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 Tongyu Communication's P/S exceeds that of its industry peers. 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 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.

What We Can Learn From Tongyu Communication's P/S?

The large bounce in Tongyu Communication's shares has lifted the company's P/S handsomely. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Tongyu Communication revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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. 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.

Before you take the next step, you should know about the 2 warning signs for Tongyu Communication that we have uncovered.

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.

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