Kimoto Co., Ltd.'s (TSE:7908) 26% Share Price Surge Not Quite Adding Up

Kimoto Co., Ltd. (TSE:7908) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 30% in the last year.

Following the firm bounce in price, given close to half the companies operating in Japan's Chemicals industry have price-to-sales ratios (or "P/S") below 0.5x, you may consider Kimoto as a stock to potentially avoid with its 1.1x 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.

View our latest analysis for Kimoto

What Does Kimoto's Recent Performance Look Like?

The revenue growth achieved at Kimoto over the last year would be more than acceptable for most companies. 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.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Kimoto's earnings, revenue and cash flow.

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

In order to justify its P/S ratio, Kimoto would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered an exceptional 22% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 12% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 6.6% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Kimoto's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate 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.

The Final Word

Kimoto shares have taken a big step in a northerly direction, but its P/S is elevated as a result. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Kimoto 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Having said that, be aware Kimoto is showing 3 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

If these risks are making you reconsider your opinion on Kimoto, 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.