What Privi Speciality Chemicals Limited's (NSE:PRIVISCL) 25% Share Price Gain Is Not Telling You

Privi Speciality Chemicals Limited (NSE:PRIVISCL) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 16% is also fairly reasonable.

Following the firm bounce in price, when almost half of the companies in India's Chemicals industry have price-to-sales ratios (or "P/S") below 1.6x, you may consider Privi Speciality Chemicals as a stock probably not worth researching with its 2.9x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

See our latest analysis for Privi Speciality Chemicals

What Does Privi Speciality Chemicals' Recent Performance Look Like?

Privi Speciality Chemicals has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. 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 Privi Speciality Chemicals, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

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

If we review the last year of revenue growth, the company posted a worthy increase of 5.1%. Revenue has also lifted 8.3% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 12% shows it's noticeably less attractive.

With this in mind, we find it worrying that Privi Speciality Chemicals' 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

Privi Speciality Chemicals shares have taken a big step in a northerly direction, but its P/S is elevated as a result. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Privi Speciality Chemicals 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Privi Speciality Chemicals, and understanding these should be part of your investment process.

If you're unsure about the strength of Privi Speciality Chemicals' 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.