hGears AG's (ETR:HGEA) 27% Share Price Plunge Could Signal Some Risk

hGears AG (ETR:HGEA) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 23% share price drop.

Although its price has dipped substantially, it's still not a stretch to say that hGears' price-to-sales (or "P/S") ratio of 0.2x right now seems quite "middle-of-the-road" compared to the Auto Components industry in Germany, seeing as it matches the P/S ratio of the wider industry. 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 hGears

How Has hGears Performed Recently?

Recent times haven't been great for hGears as its revenue has been falling quicker than most other companies. It might be that many expect the dismal revenue performance to revert back to industry averages soon, which has kept the P/S from falling. So while you could say the stock is cheap, investors will be looking for improvement before they see it as good value. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

Want the full picture on analyst estimates for the company? Then our free report on hGears will help you uncover what's on the horizon.

Do Revenue Forecasts Match The P/S Ratio?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 13%. As a result, revenue from three years ago have also fallen 23% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 5.5% each year during the coming three years according to the two analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 8.5% per annum, which is noticeably more attractive.

In light of this, it's curious that hGears' P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of revenue growth is likely to weigh down the shares eventually.

The Key Takeaway

Following hGears' share price tumble, its P/S is just clinging on to the industry median 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.

When you consider that hGears' revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for hGears 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.