Royale Home Holdings Limited (HKG:1198) May Have Run Too Fast Too Soon With Recent 35% Price Plummet

Unfortunately for some shareholders, the Royale Home Holdings Limited (HKG:1198) share price has dived 35% in the last thirty days, prolonging recent pain. For any long-term shareholders, the last month ends a year to forget by locking in a 73% share price decline.

Even after such a large drop in price, you could still be forgiven for thinking Royale Home Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 1.5x, considering almost half the companies in Hong Kong's Consumer Durables industry have P/S ratios below 0.5x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Royale Home Holdings

How Royale Home Holdings Has Been Performing

For example, consider that Royale Home Holdings' financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Royale Home Holdings' 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 high as Royale Home Holdings' is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered a frustrating 43% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 32% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 12% shows it's an unpleasant look.

With this information, we find it concerning that Royale Home Holdings 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.

What Does Royale Home Holdings' P/S Mean For Investors?

Despite the recent share price weakness, Royale Home Holdings' P/S remains higher than most other companies in the industry. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Royale Home Holdings revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Before you take the next step, you should know about the 2 warning signs for Royale Home Holdings that we have uncovered.

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.