There's Reason For Concern Over Zappallas, Inc.'s (TSE:3770) Massive 25% Price Jump

Zappallas, Inc. (TSE:3770) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 42% in the last year.

Even after such a large jump in price, it's still not a stretch to say that Zappallas' price-to-sales (or "P/S") ratio of 1.5x right now seems quite "middle-of-the-road" compared to the Interactive Media and Services industry in Japan, where the median P/S ratio is around 1.6x. 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 Zappallas

What Does Zappallas' Recent Performance Look Like?

For example, consider that Zappallas' financial performance has been poor lately as its revenue has been in decline. 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 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.

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 Zappallas' 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 Zappallas' 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 1.4%. Unfortunately, that's brought it right back to where it started three years ago with revenue growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

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

In light of this, it's curious that Zappallas' P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent revenue trends is likely to weigh down the shares eventually.

The Bottom Line On Zappallas' P/S

Zappallas appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the 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 Zappallas' average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. Right now we are uncomfortable with the P/S as this revenue performance isn't likely to support a more positive sentiment for long. If recent medium-term revenue trends continue, the probability of a share price decline will become quite substantial, placing shareholders at risk.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Zappallas (1 is potentially serious!) that you need to be mindful of.

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