iDreamSky Technology Holdings Limited (HKG:1119) shareholders have had their patience rewarded with a 27% share price jump in the last month. Looking further back, the 12% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.
Following the firm bounce in price, you could be forgiven for thinking iDreamSky Technology Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.5x, considering almost half the companies in Hong Kong's Entertainment industry have P/S ratios below 1.5x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.
Check out our latest analysis for iDreamSky Technology Holdings
How iDreamSky Technology Holdings Has Been Performing
For example, consider that iDreamSky Technology Holdings' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.
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 iDreamSky Technology Holdings' earnings, revenue and cash flow.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 iDreamSky Technology Holdings' 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 29%. The last three years don't look nice either as the company has shrunk revenue by 45% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.
Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 12% shows it's an unpleasant look.
With this information, we find it concerning that iDreamSky Technology Holdings is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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
iDreamSky Technology Holdings shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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 iDreamSky Technology Holdings currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 2 warning signs with iDreamSky Technology Holdings (at least 1 which is concerning), and understanding them should be part of your investment process.
If you're unsure about the strength of iDreamSky Technology Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.