Digital Domain Holdings Limited's (HKG:547) 35% Dip Still Leaving Some Shareholders Feeling Restless Over Its P/SRatio

Digital Domain Holdings Limited (HKG:547) shares have had a horrible month, losing 35% after a relatively good period beforehand. Longer-term, the stock has been solid despite a difficult 30 days, gaining 14% in the last year.

Although its price has dipped substantially, you could still be forgiven for thinking Digital Domain Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.1x, considering almost half the companies in Hong Kong's Entertainment industry have P/S ratios below 1.8x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Digital Domain Holdings

What Does Digital Domain Holdings' P/S Mean For Shareholders?

For example, consider that Digital Domain Holdings' financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

Is There Enough Revenue Growth Forecasted For Digital Domain Holdings?

Digital Domain Holdings' P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 23%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 22% overall rise in revenue. 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 information, we find it concerning that Digital Domain Holdings is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On Digital Domain Holdings' P/S

There's still some elevation in Digital Domain Holdings' P/S, even if the same can't be said for its share price recently. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Digital Domain Holdings 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.

Having said that, be aware Digital Domain Holdings is showing 3 warning signs in our investment analysis, and 1 of those can't be ignored.

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.