Optimistic Investors Push Covalon Technologies Ltd. (CVE:COV) Shares Up 83% But Growth Is Lacking

Covalon Technologies Ltd. (CVE:COV) shareholders would be excited to see that the share price has had a great month, posting a 83% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 4.2% isn't as attractive.

Although its price has surged higher, you could still be forgiven for feeling indifferent about Covalon Technologies' P/S ratio of 1.9x, since the median price-to-sales (or "P/S") ratio for the Biotechs industry in Canada is also close to 2.1x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

Check out our latest analysis for Covalon Technologies

What Does Covalon Technologies' Recent Performance Look Like?

Covalon Technologies has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting future revenue performance to only keep up with the broader industry, which has keeping the P/S in line with expectations. 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 not quite in 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 Covalon Technologies' earnings, revenue and cash flow.

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

There's an inherent assumption that a company should be matching the industry for P/S ratios like Covalon Technologies' to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 12% last year. Pleasingly, revenue has also lifted 264% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenues over that time.

This is in contrast to the rest of the industry, which is expected to grow by 319% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's curious that Covalon Technologies' P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. They may be setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

Covalon Technologies appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Covalon Technologies' average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. Right now we are uncomfortable with the P/S as this revenue performance isn't likely to support a more positive sentiment for long. If recent medium-term revenue trends continue, the probability of a share price decline will become quite substantial, placing shareholders at risk.

You should always think about risks. Case in point, we've spotted 2 warning signs for Covalon Technologies you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

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