Risks To Shareholder Returns Are Elevated At These Prices For Melrose Industries PLC (LON:MRO)

It's not a stretch to say that Melrose Industries PLC's (LON:MRO) price-to-sales (or "P/S") ratio of 1x right now seems quite "middle-of-the-road" for companies in the Aerospace & Defense industry in the United Kingdom, where the median P/S ratio is around 1.4x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

View our latest analysis for Melrose Industries

What Does Melrose Industries' Recent Performance Look Like?

With revenue growth that's superior to most other companies of late, Melrose Industries has been doing relatively well. It might be that many expect the strong revenue performance to wane, which has kept the P/S ratio from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Melrose Industries.

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 Melrose Industries' to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 70%. Still, revenue has fallen 11% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to slump, contracting by 19% per annum during the coming three years according to the eleven analysts following the company. Meanwhile, the broader industry is forecast to expand by 5.9% each year, which paints a poor picture.

With this information, we find it concerning that Melrose Industries is trading at a fairly similar P/S compared to the industry. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining revenues are likely to weigh on the share price eventually.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

While Melrose Industries' P/S isn't anything out of the ordinary for companies in the industry, we didn't expect it given forecasts of revenue decline. With this in mind, we don't feel the current P/S is justified as declining revenues are unlikely to support a more positive sentiment for long. If we consider the revenue outlook, the P/S seems to indicate that potential investors may be paying a premium for the stock.

Having said that, be aware Melrose Industries is showing 1 warning sign in our investment analysis, you should know about.

If you're unsure about the strength of Melrose Industries' 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.