Unpleasant Surprises Could Be In Store For KLab Inc.'s (TSE:3656) Shares

With a median price-to-sales (or "P/S") ratio of close to 1.1x in the Entertainment industry in Japan, you could be forgiven for feeling indifferent about KLab Inc.'s (TSE:3656) P/S ratio of 1x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

See our latest analysis for KLab

How Has KLab Performed Recently?

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 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.

How Is KLab's Revenue Growth Trending?

In order to justify its P/S ratio, KLab would need to produce growth that's similar to the industry.

Retrospectively, the last year delivered a frustrating 40% decrease to the company's top line. As a result, revenue from three years ago have also fallen 71% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to shrink 2.2% in the next 12 months, the company's downward momentum is still inferior based on recent medium-term annualised revenue results.

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 We Can Learn From KLab's P/S?

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of KLab revealed its sharp three-year contraction in revenue isn't impacting its P/S as much as we would have predicted, given the industry is set to shrink less severely. When we see below average revenue, we suspect the share price is at risk of declining, sending the moderate P/S lower. We're also cautious about the company's ability to stay its recent medium-term course and resist even greater pain to its business from the broader industry turmoil. This would place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 4 warning signs for KLab (1 shouldn't be ignored!) that you need to take into consideration.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com