Northeast Electric Development Company Limited's (HKG:42) Shares May Have Run Too Fast Too Soon

Northeast Electric Development Company Limited's (HKG:42) price-to-sales (or "P/S") ratio of 1.5x may not look like an appealing investment opportunity when you consider close to half the companies in the Electrical industry in Hong Kong have P/S ratios below 0.8x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

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See our latest analysis for Northeast Electric Development

How Northeast Electric Development Has Been Performing

Revenue has risen firmly for Northeast Electric Development recently, which is pleasing to see. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

The only time you'd be truly comfortable seeing a P/S as high as Northeast Electric Development's is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered an exceptional 19% gain to the company's top line. Pleasingly, revenue has also lifted 30% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 17% shows it's noticeably less attractive.

With this information, we find it concerning that Northeast Electric Development is trading at a P/S higher than the industry. 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 Northeast Electric Development's P/S Mean For Investors?

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Northeast Electric Development revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. 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. 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Northeast Electric Development you should be aware of, and 2 of them are significant.

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.