Some Confidence Is Lacking In 7Road Holdings Limited (HKG:797) As Shares Slide 29%

7Road Holdings Limited (HKG:797) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 29% in that time.

Even after such a large drop in price, when almost half of the companies in Hong Kong's Entertainment industry have price-to-sales ratios (or "P/S") below 1.7x, you may still consider 7Road Holdings as a stock not worth researching with its 6.7x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for 7Road Holdings

How Has 7Road Holdings Performed Recently?

Revenue has risen firmly for 7Road Holdings recently, which is pleasing to see. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on 7Road Holdings' earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like 7Road Holdings' to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 16% last year. Pleasingly, revenue has also lifted 48% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 21% 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 7Road Holdings' P/S exceeds that of its industry peers. 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 Key Takeaway

Even after such a strong price drop, 7Road Holdings' P/S still exceeds the industry median significantly. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

The fact that 7Road 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 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 7Road Holdings is showing 1 warning sign in our investment analysis, you should know about.

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.

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