Nanosonics Limited's (ASX:NAN) Shares Climb 29% But Its Business Is Yet to Catch Up

Nanosonics Limited (ASX:NAN) shares have had a really impressive month, gaining 29% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 18% in the last twelve months.

Since its price has surged higher, you could be forgiven for thinking Nanosonics is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.3x, considering almost half the companies in Australia's Medical Equipment industry have P/S ratios below 3.5x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Nanosonics

What Does Nanosonics' Recent Performance Look Like?

With revenue growth that's inferior to most other companies of late, Nanosonics has been relatively sluggish. Perhaps the market is expecting future revenue performance to undergo a reversal of fortunes, which has elevated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

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.

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

Nanosonics' P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. However, a few strong years before that means that it was still able to grow revenue by an impressive 65% in total over the last three years. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

Turning to the outlook, the next three years should generate growth of 10% per annum as estimated by the twelve analysts watching the company. With the industry predicted to deliver 11% growth each year, the company is positioned for a comparable revenue result.

With this information, we find it interesting that Nanosonics is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Nanosonics' P/S

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

Given Nanosonics' future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. 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.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Nanosonics that you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.