There's Reason For Concern Over Sprocomm Intelligence Limited's (HKG:1401) Massive 27% Price Jump

Sprocomm Intelligence Limited (HKG:1401) shares have continued their recent momentum with a 27% gain in the last month alone. Unfortunately, despite the strong performance over the last month, the full year gain of 2.6% isn't as attractive.

Since its price has surged higher, you could be forgiven for thinking Sprocomm Intelligence is a stock not worth researching with a price-to-sales ratios (or "P/S") of 1.1x, considering almost half the companies in Hong Kong's Tech industry have P/S ratios below 0.6x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Sprocomm Intelligence

What Does Sprocomm Intelligence's Recent Performance Look Like?

Sprocomm Intelligence certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. It seems that many are expecting the strong 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 might be a little nervous about the viability of the share price.

Although there are no analyst estimates available for Sprocomm Intelligence, 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?

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

Taking a look back first, we see that the company grew revenue by an impressive 143% last year. The latest three year period has also seen an excellent 46% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Comparing that to the industry, which is predicted to deliver 19% 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 Sprocomm Intelligence's P/S sits above the majority of other companies. 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 Sprocomm Intelligence's P/S?

The large bounce in Sprocomm Intelligence's 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 Sprocomm Intelligence 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 the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Sprocomm Intelligence (1 is a bit unpleasant) you should be aware of.

If you're unsure about the strength of Sprocomm Intelligence's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.