Nelco Limited's (NSE:NELCO) 44% Share Price Surge Not Quite Adding Up

Nelco Limited (NSE:NELCO) shares have continued their recent momentum with a 44% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 34% in the last year.

Since its price has surged higher, Nelco's price-to-sales (or "P/S") ratio of 8.2x might make it look like a strong sell right now compared to other companies in the Communications industry in India, where around half of the companies have P/S ratios below 4.3x and even P/S below 1.2x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Nelco

What Does Nelco's Recent Performance Look Like?

We'd have to say that with no tangible growth over the last year, Nelco's revenue has been unimpressive. It might be that many are expecting an improvement to the uninspiring revenue performance over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

Is There Enough Revenue Growth Forecasted For Nelco?

Nelco's 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.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Although pleasingly revenue has lifted 36% in aggregate from three years ago, notwithstanding the last 12 months. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

This is in contrast to the rest of the industry, which is expected to grow by 42% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Nelco's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

What We Can Learn From Nelco's P/S?

Nelco's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Nelco 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. 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.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Nelco 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.

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

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.