Ecofibre Limited's (ASX:EOF) 30% Dip In Price Shows Sentiment Is Matching Revenues

Ecofibre Limited (ASX:EOF) shares have retraced a considerable 30% in the last month, reversing a fair amount of their solid recent performance. For any long-term shareholders, the last month ends a year to forget by locking in a 72% share price decline.

Since its price has dipped substantially, Ecofibre may be sending very bullish signals at the moment with its price-to-sales (or "P/S") ratio of 0.4x, since almost half of all companies in the Pharmaceuticals industry in Australia have P/S ratios greater than 4.9x and even P/S higher than 35x are not unusual. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so limited.

View our latest analysis for Ecofibre

How Ecofibre Has Been Performing

As an illustration, revenue has deteriorated at Ecofibre over the last year, which is not ideal at all. 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. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

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.

Do Revenue Forecasts Match The Low P/S Ratio?

There's an inherent assumption that a company should far underperform the industry for P/S ratios like Ecofibre's 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 8.7%. As a result, revenue from three years ago have also fallen 2.8% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 161% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we are not surprised that Ecofibre is trading at a P/S lower than the industry. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

What We Can Learn From Ecofibre's P/S?

Ecofibre's P/S looks about as weak as its stock price lately. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

It's no surprise that Ecofibre maintains its low P/S off the back of its sliding revenue over the medium-term. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Ecofibre that you should be aware of.

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.