Virtual Mind Holding Company Limited's (HKG:1520) Shares Climb 28% But Its Business Is Yet to Catch Up

Virtual Mind Holding Company Limited (HKG:1520) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Taking a wider view, although not as strong as the last month, the full year gain of 21% is also fairly reasonable.

After such a large jump in price, when almost half of the companies in Hong Kong's Luxury industry have price-to-sales ratios (or "P/S") below 0.5x, you may consider Virtual Mind Holding as a stock not worth researching with its 3.1x 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.

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View our latest analysis for Virtual Mind Holding

How Virtual Mind Holding Has Been Performing

Virtual Mind Holding certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. 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. 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 Virtual Mind Holding's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered an exceptional 95% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 7.3% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Virtual Mind Holding's P/S exceeds that of its industry peers. 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 We Can Learn From Virtual Mind Holding's P/S?

The strong share price surge has lead to Virtual Mind Holding's P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Virtual Mind Holding 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. 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.

Having said that, be aware Virtual Mind Holding is showing 3 warning signs in our investment analysis, and 1 of those is a bit concerning.

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.