KLab Inc.'s (TSE:3656) 26% Share Price Plunge Could Signal Some Risk

KLab Inc. (TSE:3656) shares have had a horrible month, losing 26% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 33% in that time.

Even after such a large drop in price, there still wouldn't be many who think KLab's price-to-sales (or "P/S") ratio of 1x is worth a mention when the median P/S in Japan's Entertainment industry is similar at about 1.1x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

View our latest analysis for KLab

What Does KLab's Recent Performance Look Like?

As an illustration, revenue has deteriorated at KLab over the last year, which is not ideal at all. Perhaps investors believe the recent revenue performance is enough to keep in line with the industry, which is keeping the P/S from dropping off. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

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

How Is KLab's Revenue Growth Trending?

There's an inherent assumption that a company should be matching the industry for P/S ratios like KLab'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 37%. As a result, revenue from three years ago have also fallen 68% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to decline by 0.4% over the next year, or less than the company's recent medium-term annualised revenue decline.

With this information, it's perhaps strange that KLab is trading at a fairly similar P/S in comparison. In general, when revenue shrink rapidly the P/S often shrinks too, which could set up shareholders for future disappointment. There's potential for the P/S to fall to lower levels if the company doesn't improve its top-line growth, which would be difficult to do with the current industry outlook.

What Does KLab's P/S Mean For Investors?

With its share price dropping off a cliff, the P/S for KLab looks to be in line with the rest of the Entertainment industry. 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.

We've established that KLab currently trades on a higher than expected P/S since its recent three-year revenues are even worse than the forecasts for a struggling industry. When we see below average revenue, we suspect the share price is at risk of declining, sending the moderate P/S lower. In addition, we would be concerned whether the company can even maintain its medium-term level of performance under these tough industry conditions. This would place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about these 3 warning signs we've spotted with KLab (including 2 which are a bit unpleasant).

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.