Investor Optimism Abounds Northeast Electric Development Company Limited (HKG:42) But Growth Is Lacking

When close to half the companies in the Electrical industry in Hong Kong have price-to-sales ratios (or "P/S") below 0.6x, you may consider Northeast Electric Development Company Limited (HKG:42) as a stock to potentially avoid with its 1.5x 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.

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View our latest analysis for Northeast Electric Development

How Northeast Electric Development Has Been Performing

Recent times have been quite advantageous for Northeast Electric Development as its revenue has been rising very briskly. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. 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?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Northeast Electric Development's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 42% last year. The latest three year period has also seen an excellent 31% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

Weighing that recent medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 11% shows it's about the same on an annualised basis.

With this in mind, we find it intriguing that Northeast Electric Development's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent revenue trends would weigh down the share price eventually.

The Bottom Line On Northeast Electric Development's P/S

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.

We didn't expect to see Northeast Electric Development trade at such a high P/S considering its last three-year revenue growth has only been on par with the rest of the industry. When we see average revenue with industry-like growth combined with a high P/S, we suspect the share price is at risk of declining, bringing the P/S back in line with the industry too. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 4 warning signs for Northeast Electric Development you should be aware of, and 2 of them can't be ignored.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.