There's Reason For Concern Over Step One Clothing Limited's (ASX:STP) Massive 38% Price Jump

Step One Clothing Limited (ASX:STP) shares have continued their recent momentum with a 38% gain in the last month alone. The annual gain comes to 257% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, given around half the companies in Australia's Specialty Retail industry have price-to-sales ratios (or "P/S") below 0.6x, you may consider Step One Clothing as a stock to avoid entirely with its 2.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Step One Clothing

How Has Step One Clothing Performed Recently?

Step One Clothing could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. However, if this isn't the case, investors might get caught out paying too much for the stock.

Keen to find out how analysts think Step One Clothing's future stacks up against the industry? In that case, our free report is a great place to start.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Step One Clothing would need to produce outstanding growth that's well in excess of the industry.

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 9.7%. Even so, admirably revenue has lifted 193% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Shifting to the future, estimates from the one analyst covering the company suggest revenue should grow by 7.8% per year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 7.8% per year, which is not materially different.

With this information, we find it interesting that Step One Clothing is trading at a high P/S compared to the industry. 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.

The Key Takeaway

Shares in Step One Clothing have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Step One Clothing currently trades on a higher than expected P/S. 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.

Plus, you should also learn about these 2 warning signs we've spotted with Step One Clothing.

If these risks are making you reconsider your opinion on Step One Clothing, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.