There's Reason For Concern Over KLab Inc.'s (TSE:3656) Massive 28% Price Jump

KLab Inc. (TSE:3656) shares have continued their recent momentum with a 28% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 50%.

After such a large jump in price, given close to half the companies operating in Japan's Entertainment industry have price-to-sales ratios (or "P/S") below 1.2x, you may consider KLab as a stock to potentially avoid with its 2x 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.

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Check out our latest analysis for KLab

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

As an illustration, revenue has deteriorated at KLab 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. 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 KLab's earnings, revenue and cash flow.

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

There's an inherent assumption that a company should outperform 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 13%. As a result, revenue from three years ago have also fallen 61% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 32% shows it's an unpleasant look.

With this information, we find it concerning that KLab 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Bottom Line On KLab's P/S

The large bounce in KLab's shares has lifted the company's P/S handsomely. 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've established that KLab currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

It is also worth noting that we have found 4 warning signs for KLab (3 are potentially serious!) that you need to take into consideration.

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