There's Reason For Concern Over Nakamura Choukou Co., Ltd.'s (TSE:6166) Massive 26% Price Jump

Nakamura Choukou Co., Ltd. (TSE:6166) shareholders have had their patience rewarded with a 26% share price jump in the last month. Unfortunately, despite the strong performance over the last month, the full year gain of 3.6% isn't as attractive.

Since its price has surged higher, given close to half the companies operating in Japan's Machinery industry have price-to-sales ratios (or "P/S") below 0.7x, you may consider Nakamura Choukou as a stock to potentially avoid with its 2x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Nakamura Choukou

What Does Nakamura Choukou's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Nakamura Choukou over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for Nakamura Choukou, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Nakamura Choukou's Revenue Growth Trending?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 6.9%. This means it has also seen a slide in revenue over the longer-term as revenue is down 39% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 5.5% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Nakamura Choukou is trading at a P/S higher than the industry. 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 Nakamura Choukou's P/S?

Nakamura Choukou 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 Nakamura Choukou revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

There are also other vital risk factors to consider and we've discovered 4 warning signs for Nakamura Choukou (1 is a bit concerning!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Nakamura Choukou, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.