There's Reason For Concern Over Convano Inc.'s (TSE:6574) Massive 35% Price Jump

The Convano Inc. (TSE:6574) share price has done very well over the last month, posting an excellent gain of 35%. The annual gain comes to 109% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, given around half the companies in Japan's Consumer Services industry have price-to-sales ratios (or "P/S") below 0.9x, you may consider Convano as a stock to avoid entirely with its 3.7x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.

See our latest analysis for Convano

How Convano Has Been Performing

Convano has been doing a good job lately as it's been growing revenue at a solid pace. 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 Convano will help you shine a light on its historical performance.

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Convano would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 13%. The latest three year period has also seen an excellent 39% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Weighing that recent medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 12% shows it's about the same on an annualised basis.

With this in mind, we find it intriguing that Convano's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Nevertheless, they may be setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Bottom Line On Convano's P/S

The strong share price surge has lead to Convano's P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Convano revealed its three-year revenue trends aren't impacting its high P/S as much as we would have predicted, given they look similar to current industry expectations. Right now we are uncomfortable 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 trends, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Having said that, be aware Convano is showing 3 warning signs in our investment analysis, and 2 of those are concerning.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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.