Revenues Not Telling The Story For Merit Interactive Co.,Ltd. (SZSE:300766) After Shares Rise 28%

The Merit Interactive Co.,Ltd. (SZSE:300766) share price has done very well over the last month, posting an excellent gain of 28%. Looking back a bit further, it's encouraging to see the stock is up 51% in the last year.

Following the firm bounce in price, Merit InteractiveLtd's price-to-sales (or "P/S") ratio of 16.7x might 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 4.2x and even P/S below 2x 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 P/S Mean For Shareholders?

It looks like revenue growth has deserted Merit InteractiveLtd recently, which is not something to boast about. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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 Merit InteractiveLtd's earnings, revenue and cash flow.

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

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.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. 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. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 17% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Merit InteractiveLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

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

Merit InteractiveLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Merit InteractiveLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

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

If you're unsure about the strength of Merit InteractiveLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.