What Zip Co Limited's (ASX:ZIP) 27% Share Price Gain Is Not Telling You

Zip Co Limited (ASX:ZIP) shares have continued their recent momentum with a 27% gain in the last month alone. This latest share price bounce rounds out a remarkable 662% gain over the last twelve months.

Following the firm bounce in price, given close to half the companies operating in Australia's Consumer Finance industry have price-to-sales ratios (or "P/S") below 1.6x, you may consider Zip Co as a stock to potentially avoid with its 3.5x 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.

See our latest analysis for Zip Co

What Does Zip Co's Recent Performance Look Like?

Zip Co certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. If not, then existing shareholders might be a little nervous about the viability of the share price.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Zip Co.

Is There Enough Revenue Growth Forecasted For Zip Co?

Zip Co's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 25%. The strong recent performance means it was also able to grow revenue by 120% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Shifting to the future, estimates from the six analysts covering the company suggest revenue should grow by 11% per annum over the next three years. Meanwhile, the rest of the industry is forecast to expand by 14% per annum, which is noticeably more attractive.

In light of this, it's alarming that Zip Co's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Zip Co's P/S

Zip Co's P/S is on the rise since its shares have risen strongly. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've concluded that Zip Co currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Zip Co that you need to be mindful of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.