There's Reason For Concern Over Digital Domain Holdings Limited's (HKG:547) Massive 27% Price Jump

Despite an already strong run, Digital Domain Holdings Limited (HKG:547) shares have been powering on, with a gain of 27% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 56% in the last year.

Following the firm bounce in price, given around half the companies in Hong Kong's Entertainment industry have price-to-sales ratios (or "P/S") below 1.6x, you may consider Digital Domain Holdings as a stock to avoid entirely with its 3.8x 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.

See our latest analysis for Digital Domain Holdings

What Does Digital Domain Holdings' Recent Performance Look Like?

As an illustration, revenue has deteriorated at Digital Domain Holdings over the last year, which is not ideal at all. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Digital Domain Holdings will help you shine a light on its historical performance.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a frustrating 4.5% decrease to the company's top line. However, a few very strong years before that means that it was still able to grow revenue by an impressive 49% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 48% 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.

What We Can Learn From Digital Domain Holdings' P/S?

Digital Domain Holdings' P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

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 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Digital Domain Holdings, and understanding them should be part of your investment process.

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.