Energy One Limited's (ASX:EOL) Shares Climb 27% But Its Business Is Yet to Catch Up

Energy One Limited (ASX:EOL) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. The annual gain comes to 267% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Energy One may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 9.4x, since almost half of all companies in the Software industry in Australia have P/S ratios under 3.7x and even P/S lower than 1.4x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

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See our latest analysis for Energy One

How Has Energy One Performed Recently?

Energy One could be doing better as it's been growing revenue less than most other companies lately. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Energy One.

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

Energy One's 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.

Retrospectively, the last year delivered an exceptional 17% gain to the company's top line. The latest three year period has also seen an excellent 90% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Shifting to the future, estimates from the dual analysts covering the company suggest revenue should grow by 13% per annum over the next three years. Meanwhile, the rest of the industry is forecast to expand by 50% per year, which is noticeably more attractive.

With this in consideration, we believe it doesn't make sense that Energy One's P/S is outpacing its industry peers. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

Shares in Energy One have seen a strong upwards swing lately, which has really helped boost its P/S figure. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Energy One, this doesn't appear to be impacting the P/S in the slightest. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.