There's Reason For Concern Over Frontier Developments plc's (LON:FDEV) Massive 28% Price Jump

Despite an already strong run, Frontier Developments plc (LON:FDEV) shares have been powering on, with a gain of 28% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 98% in the last year.

Although its price has surged higher, there still wouldn't be many who think Frontier Developments' price-to-sales (or "P/S") ratio of 1.8x is worth a mention when the median P/S in the United Kingdom's Entertainment industry is similar at about 1.7x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

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View our latest analysis for Frontier Developments

How Frontier Developments Has Been Performing

With revenue growth that's inferior to most other companies of late, Frontier Developments has been relatively sluggish. Perhaps the market is expecting future revenue performance to lift, which has kept the P/S from declining. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

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 Frontier Developments' to be considered reasonable.

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 21% decline in revenue over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Shifting to the future, estimates from the seven analysts covering the company suggest revenue should grow by 3.0% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 13% per annum, which is noticeably more attractive.

With this in mind, we find it intriguing that Frontier Developments' P/S is closely matching its industry peers. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

Its shares have lifted substantially and now Frontier Developments' P/S is back within range of the industry median. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our look at the analysts forecasts of Frontier Developments' revenue prospects has shown that its inferior revenue outlook isn't negatively impacting its P/S as much as we would have predicted. 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Frontier Developments (1 is potentially serious) you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.