Zappallas, Inc.'s (TSE:3770) Price Is Right But Growth Is Lacking After Shares Rocket 26%

Zappallas, Inc. (TSE:3770) shares have continued their recent momentum with a 26% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 12% is also fairly reasonable.

Although its price has surged higher, when close to half the companies operating in Japan's Interactive Media and Services industry have price-to-sales ratios (or "P/S") above 1.5x, you may still consider Zappallas as an enticing stock to check out with its 1x P/S ratio. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

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Check out our latest analysis for Zappallas

How Zappallas Has Been Performing

As an illustration, revenue has deteriorated at Zappallas over the last year, which is not ideal at all. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. Those who are bullish on Zappallas will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

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

How Is Zappallas' Revenue Growth Trending?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Zappallas' to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 2.6%. The last three years don't look nice either as the company has shrunk revenue by 15% in aggregate. 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 deliver 9.1% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we understand why Zappallas' P/S is lower than most of its industry peers. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Final Word

Despite Zappallas' share price climbing recently, its P/S still lags most other companies. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Zappallas revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

Before you settle on your opinion, we've discovered 2 warning signs for Zappallas that you should be aware of.

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.