Dongguan Mentech Optical & Magnetic Co., Ltd. (SZSE:002902) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. Still, a bad month hasn't completely ruined the past year with the stock gaining 44%, which is great even in a bull market.

After such a large drop in price, Dongguan Mentech Optical & Magnetic may be sending bullish signals at the moment with its price-to-sales (or "P/S") ratio of 2.5x, since almost half of all companies in the Electronic industry in China have P/S ratios greater than 3.6x and even P/S higher than 7x are not unusual. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

How Has Dongguan Mentech Optical & Magnetic Performed Recently?

While the industry has experienced revenue growth lately, Dongguan Mentech Optical & Magnetic's revenue has gone into reverse gear, which is not great. The P/S ratio is probably low because investors think this poor revenue performance isn't going to get any better. If you still like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Do Revenue Forecasts Match The Low P/S Ratio?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Dongguan Mentech Optical & Magnetic's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 5.2%. However, a few very strong years before that means that it was still able to grow revenue by an impressive 39% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 4.1% during the coming year according to the only analyst following the company. With the industry predicted to deliver 23% growth, the company is positioned for a weaker revenue result.

With this information, we can see why Dongguan Mentech Optical & Magnetic is trading at a P/S lower than the industry. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

The southerly movements of Dongguan Mentech Optical & Magnetic's shares means its P/S is now sitting at a pretty low level. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Dongguan Mentech Optical & Magnetic maintains its low P/S on the weakness of its forecast growth being lower than the wider industry, as expected. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Dongguan Mentech Optical & Magnetic you should know about.

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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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.