Perfect World Co., Ltd. (SZSE:002624) Soars 39% But It's A Story Of Risk Vs Reward

Perfect World Co., Ltd. (SZSE:002624) shares have continued their recent momentum with a 39% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 8.9% in the last twelve months.

In spite of the firm bounce in price, Perfect World may still be sending bullish signals at the moment with its price-to-sales (or "P/S") ratio of 4.2x, since almost half of all companies in the Entertainment industry in China have P/S ratios greater than 7.1x and even P/S higher than 15x are not unusual. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Perfect World

How Has Perfect World Performed Recently?

Perfect World hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. Perhaps the P/S remains low as investors think the prospects of strong revenue growth aren't on the horizon. If you still 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.

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

Do Revenue Forecasts Match The Low P/S Ratio?

In order to justify its P/S ratio, Perfect World would need to produce sluggish growth that's trailing 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 30%. The last three years don't look nice either as the company has shrunk revenue by 36% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest revenue should grow by 30% over the next year. Meanwhile, the rest of the industry is forecast to expand by 32%, which is not materially different.

With this in consideration, we find it intriguing that Perfect World's P/S is lagging behind its industry peers. It may be that most investors are not convinced the company can achieve future growth expectations.

The Bottom Line On Perfect World's P/S

The latest share price surge wasn't enough to lift Perfect World's P/S close to the industry median. 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.

We've seen that Perfect World currently trades on a lower than expected P/S since its forecast growth is in line with the wider industry. The low P/S could be an indication that the revenue growth estimates are being questioned by the market. At least the risk of a price drop looks to be subdued, but investors seem to think future revenue could see some volatility.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Perfect World 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.