FRONTEO, Inc.'s (TSE:2158) Shares Climb 33% But Its Business Is Yet to Catch Up

FRONTEO, Inc. (TSE:2158) shareholders are no doubt pleased to see that the share price has bounced 33% in the last month, although it is still struggling to make up recently lost ground. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 3.5% over the last year.

Following the firm bounce in price, when almost half of the companies in Japan's IT industry have price-to-sales ratios (or "P/S") below 1x, you may consider FRONTEO as a stock not worth researching with its 3.4x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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Check out our latest analysis for FRONTEO

What Does FRONTEO's Recent Performance Look Like?

FRONTEO's revenue growth of late has been pretty similar to most other companies. It might be that many expect the mediocre revenue performance to strengthen positively, which has kept the P/S ratio from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as FRONTEO's is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a worthy increase of 3.8%. Still, lamentably revenue has fallen 39% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Looking ahead now, revenue is anticipated to slump, contracting by 4.7% during the coming year according to the one analyst following the company. That's not great when the rest of the industry is expected to grow by 7.4%.

With this in mind, we find it intriguing that FRONTEO's P/S is closely matching its industry peers. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the negative growth outlook.

The Final Word

FRONTEO's P/S has grown nicely over the last month thanks to a handy boost in the share price. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

For a company with revenues that are set to decline in the context of a growing industry, FRONTEO's P/S is much higher than we would've anticipated. In cases like this where we see revenue decline on the horizon, we suspect the share price is at risk of following suit, bringing back the high P/S into the realms of suitability. Unless these conditions improve markedly, it'll be a challenging time for shareholders.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for FRONTEO with six simple checks on some of these key factors.

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