More Unpleasant Surprises Could Be In Store For Merit Interactive Co.,Ltd.'s (SZSE:300766) Shares After Tumbling 27%

The Merit Interactive Co.,Ltd. (SZSE:300766) share price has fared very poorly over the last month, falling by a substantial 27%. For any long-term shareholders, the last month ends a year to forget by locking in a 55% share price decline.

Although its price has dipped substantially, given around half the companies in China's IT industry have price-to-sales ratios (or "P/S") below 3.2x, you may still consider Merit InteractiveLtd as a stock to avoid entirely with its 8.8x 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.

View our latest analysis for Merit InteractiveLtd

What Does Merit InteractiveLtd's P/S Mean For Shareholders?

Merit InteractiveLtd 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. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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

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

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Merit InteractiveLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 10% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Looking ahead now, revenue is anticipated to climb by 40% during the coming year according to the sole analyst following the company. That's shaping up to be similar to the 40% growth forecast for the broader industry.

With this information, we find it interesting that Merit InteractiveLtd is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

A significant share price dive has done very little to deflate Merit InteractiveLtd's very lofty P/S. 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.

Given Merit InteractiveLtd's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. A positive change is needed in order to justify the current price-to-sales ratio.

Before you settle on your opinion, we've discovered 3 warning signs for Merit InteractiveLtd (1 is concerning!) 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.