Risks To Shareholder Returns Are Elevated At These Prices For KLab Inc. (TSE:3656)

It's not a stretch to say that KLab Inc.'s (TSE:3656) price-to-sales (or "P/S") ratio of 0.7x right now seems quite "middle-of-the-road" for companies in the Entertainment industry in Japan, where the median P/S ratio is around 1.2x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

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View our latest analysis for KLab

What Does KLab's Recent Performance Look Like?

For instance, KLab's receding revenue in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

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

The only time you'd be comfortable seeing a P/S like KLab's is when the company's growth is tracking the industry closely.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 22%. As a result, revenue from three years ago have also fallen 65% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.

With this in mind, we find it worrying that KLab'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 on the share price eventually.

The Bottom Line On KLab's P/S

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We find it unexpected that KLab trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

You should always think about risks. Case in point, we've spotted 4 warning signs for KLab you should be aware of, and 1 of them doesn't sit too well with us.

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.

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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.