There's Reason For Concern Over Digital Domain Holdings Limited's (HKG:547) Massive 29% Price Jump

Digital Domain Holdings Limited (HKG:547) shares have continued their recent momentum with a 29% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 96% in the last year.

Following the firm bounce in price, you could be forgiven for thinking Digital Domain Holdings is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.3x, considering almost half the companies in Hong Kong's Entertainment industry have P/S ratios below 1.7x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

View 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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.

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

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune 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. 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.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 20% shows it's noticeably less attractive.

With this in mind, we find it worrying that Digital Domain Holdings' 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 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. 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.

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. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Digital Domain Holdings (of which 1 can't be ignored!) you should know about.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.