Grafenia Plc's (LON:GRA) Shares May Have Run Too Fast Too Soon

When close to half the companies in the Commercial Services industry in the United Kingdom have price-to-sales ratios (or "P/S") below 1x, you may consider Grafenia Plc (LON:GRA) as a stock to avoid entirely with its 3.6x 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 Grafenia

How Grafenia Has Been Performing

With revenue growth that's exceedingly strong of late, Grafenia has been doing very well. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

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 Grafenia's earnings, revenue and cash flow.

How Is Grafenia's Revenue Growth Trending?

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

If we review the last year of revenue growth, the company posted a terrific increase of 31%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 25% drop in revenue in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 10% shows it's an unpleasant look.

With this information, we find it concerning that Grafenia 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 Final Word

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.

We've established that Grafenia currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Grafenia (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.