Mega Genomics Limited's (HKG:6667) Share Price Could Signal Some Risk

When you see that almost half of the companies in the Healthcare industry in Hong Kong have price-to-sales ratios (or "P/S") below 1.4x, Mega Genomics Limited (HKG:6667) looks to be giving off strong sell signals with its 13.1x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Mega Genomics

How Has Mega Genomics Performed Recently?

For example, consider that Mega Genomics' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for Mega Genomics, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Mega Genomics would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 39%. Regardless, revenue has managed to lift by a handy 18% in aggregate from three years ago, thanks to the earlier period of growth. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the industry, which is expected to grow by 20% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Mega Genomics' P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates 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 Mega Genomics' P/S Mean For Investors?

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 examination of Mega Genomics revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Mega Genomics, and understanding 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.