Digital Domain Holdings Limited's (HKG:547) 35% Price Boost Is Out Of Tune With Revenues

Digital Domain Holdings Limited (HKG:547) shareholders are no doubt pleased to see that the share price has bounced 35% in the last month, although it is still struggling to make up recently lost ground. Looking back a bit further, it's encouraging to see the stock is up 55% in the last year.

After such a large jump in price, you could be forgiven for thinking Digital Domain Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.5x, considering almost half the companies in Hong Kong's Entertainment industry have P/S ratios below 1.6x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Digital Domain Holdings

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

As an illustration, revenue has deteriorated at Digital Domain Holdings over the last year, which is not ideal at all. 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. 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.

How Is Digital Domain Holdings' Revenue Growth Trending?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Digital Domain Holdings' to be considered reasonable.

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%. Regardless, revenue has managed to lift by a handy 22% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

Comparing that to the industry, which is predicted to deliver 20% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's alarming that Digital Domain Holdings' P/S sits above the majority of other companies. 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.

The Final Word

The large bounce in Digital Domain Holdings' shares has lifted the company's P/S handsomely. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

The fact that Digital Domain Holdings currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You need to take note of risks, for example - Digital Domain Holdings has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com