There's Reason For Concern Over KLab Inc.'s (TSE:3656) Massive 65% Price Jump
Despite an already strong run, KLab Inc. (TSE:3656) shares have been powering on, with a gain of 65% in the last thirty days. The last month tops off a massive increase of 117% in the last year.
Following the firm bounce in price, given close to half the companies operating in Japan's Entertainment industry have price-to-sales ratios (or "P/S") below 1.2x, you may consider KLab as a stock to potentially avoid with its 3.1x P/S ratio. 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.
View our latest analysis for KLab
How Has KLab Performed Recently?
For example, consider that KLab's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on KLab's earnings, revenue and cash flow.What Are Revenue Growth Metrics Telling Us About The High P/S?
KLab's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.
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 15%. This means it has also seen a slide in revenue over the longer-term as revenue is down 59% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.
Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.
With this in mind, we find it worrying that KLab'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. 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.
The Key Takeaway
KLab's P/S is on the rise since its shares have risen strongly. 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 KLab 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with KLab (at least 3 which make us uncomfortable), and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on KLab, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.