Merit Interactive Co.,Ltd. (SZSE:300766) May Have Run Too Fast Too Soon With Recent 29% Price Plummet

Merit Interactive Co.,Ltd. (SZSE:300766) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. Of course, over the longer-term many would still wish they owned shares as the stock's price has soared 227% in the last twelve months.

In spite of the heavy fall in price, Merit InteractiveLtd's price-to-sales (or "P/S") ratio of 42.4x might still make it look like a strong sell right now compared to other companies in the IT industry in China, where around half of the companies have P/S ratios below 6.2x and even P/S below 3x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

Check out our latest analysis for Merit InteractiveLtd

What Does Merit InteractiveLtd's Recent Performance Look Like?

For example, consider that Merit InteractiveLtd's financial performance has been pretty ordinary lately as revenue growth is non-existent. One possibility is that the P/S is high because investors think the benign revenue growth will improve to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Although there are no analyst estimates available for Merit InteractiveLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Merit InteractiveLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Merit InteractiveLtd's is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. This isn't what shareholders were looking for as it means they've been left with a 22% decline in revenue over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 17% shows it's an unpleasant look.

With this information, we find it concerning that Merit InteractiveLtd is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Merit InteractiveLtd's P/S

A significant share price dive has done very little to deflate Merit InteractiveLtd's very lofty P/S. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Merit InteractiveLtd revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It is also worth noting that we have found 2 warning signs for Merit InteractiveLtd that you need to take into consideration.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.