Ecofibre Limited (ASX:EOF) Might Not Be As Mispriced As It Looks After Plunging 39%

Ecofibre Limited (ASX:EOF) shareholders that were waiting for something to happen have been dealt a blow with a 39% share price drop in the last month. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 67% loss during that time.

Since its price has dipped substantially, Ecofibre may look like a strong buying opportunity at present with its price-to-sales (or "P/S") ratio of 0.8x, considering almost half of all companies in the Pharmaceuticals industry in Australia have P/S ratios greater than 6x and even P/S higher than 25x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/S.

See our latest analysis for Ecofibre

What Does Ecofibre's Recent Performance Look Like?

For example, consider that Ecofibre's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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 Ecofibre's earnings, revenue and cash flow.

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

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

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 2.1%. As a result, revenue from three years ago have also fallen 18% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to decline by 32% over the next year, even worse than the company's recent medium-term annualised revenue decline.

With this information, it's perhaps strange but not a major surprise that Ecofibre is trading at a lower P/S in comparison. There's no guarantee the P/S has found a floor yet with recent revenue going backwards, despite the industry heading down even harder. Even just maintaining these prices will be difficult to achieve as recent revenue trends are already weighing down the shares excessively.

The Bottom Line On Ecofibre's P/S

Shares in Ecofibre have plummeted and its P/S has followed suit. 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 Ecofibre revealed its narrower three-year contraction in revenue isn't contributing to its P/S anywhere near as much as we would have predicted, given the industry is set to shrink even more. When we see better than average revenue growth but a lower than average P/S, we must assume that potential risks are what might be placing significant pressure on the P/S ratio. We'd hazard a guess that some investors are concerned about the company's revenue performance tailing off amidst these tough industry conditions. While recent medium-term revenue trends suggest that the risk of a price decline is low, investors appear to perceive a possibility of revenue volatility in the future.

Plus, you should also learn about these 4 warning signs we've spotted with Ecofibre (including 2 which can't be ignored).

If you're unsure about the strength of Ecofibre's 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.