Optimistic Investors Push Avantel Limited (NSE:AVANTEL) Shares Up 40% But Growth Is Lacking

Avantel Limited (NSE:AVANTEL) shareholders would be excited to see that the share price has had a great month, posting a 40% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 2.5% isn't as attractive.

Following the firm bounce in price, given around half the companies in India's Communications industry have price-to-sales ratios (or "P/S") below 3x, you may consider Avantel as a stock to avoid entirely with its 18.8x 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.

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Check out our latest analysis for Avantel

What Does Avantel's P/S Mean For Shareholders?

Revenue has risen firmly for Avantel recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Avantel's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 20% gain to the company's top line. Pleasingly, revenue has also lifted 111% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 37% shows it's noticeably less attractive.

With this in mind, we find it worrying that Avantel's 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 Avantel's P/S?

Shares in Avantel have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

The fact that Avantel 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. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. 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.

It is also worth noting that we have found 2 warning signs for Avantel that you need to take into consideration.

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.