Advantest Corporation's (TSE:6857) Shares Climb 27% But Its Business Is Yet to Catch Up

Advantest Corporation (TSE:6857) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 34% in the last year.

Since its price has surged higher, you could be forgiven for thinking Advantest is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 10.3x, considering almost half the companies in Japan's Semiconductor industry have P/S ratios below 2.1x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Advantest

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

Advantest has been struggling lately as its revenue has declined faster than most other companies. One possibility is that the P/S ratio is high because investors think the company will turn things around completely and accelerate past most others in the industry. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Advantest.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Advantest would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 13%. Still, the latest three year period has seen an excellent 56% overall rise in revenue, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 15% per year as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 15% per annum, which is not materially different.

In light of this, it's curious that Advantest's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Advantest's P/S Mean For Investors?

The strong share price surge has lead to Advantest's P/S soaring as well. 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.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Advantest currently trades on a higher than expected P/S. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

You should always think about risks. Case in point, we've spotted 2 warning signs for Advantest you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.

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