Nanosonics Limited's (ASX:NAN) Shares Climb 26% But Its Business Is Yet to Catch Up

Despite an already strong run, Nanosonics Limited (ASX:NAN) shares have been powering on, with a gain of 26% in the last thirty days. The last 30 days bring the annual gain to a very sharp 76%.

Following the firm bounce in price, given around half the companies in Australia's Medical Equipment industry have price-to-sales ratios (or "P/S") below 3.6x, you may consider Nanosonics as a stock to avoid entirely with its 7.7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Nanosonics

What Does Nanosonics' P/S Mean For Shareholders?

There hasn't been much to differentiate Nanosonics' and the industry's revenue growth lately. It might be that many expect the mediocre revenue performance to strengthen positively, which has kept the P/S ratio from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

Want the full picture on analyst estimates for the company? Then our free report on Nanosonics will help you uncover what's on the horizon.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a decent 12% gain to the company's revenues. The latest three year period has also seen an excellent 53% overall rise in revenue, aided somewhat by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the ten analysts watching the company. That's shaping up to be similar to the 12% per annum growth forecast for the broader industry.

In light of this, it's curious that Nanosonics' P/S sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Nanosonics' P/S Mean For Investors?

The strong share price surge has lead to Nanosonics' P/S soaring as well. 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.

Analysts are forecasting Nanosonics' revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Nanosonics with six simple checks.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.