Why Investors Shouldn't Be Surprised By FRONTEO, Inc.'s (TSE:2158) 26% Share Price Surge

FRONTEO, Inc. (TSE:2158) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 31% in the last year.

Following the firm bounce in price, you could be forgiven for thinking FRONTEO is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 4.8x, considering almost half the companies in Japan's IT industry have P/S ratios below 1.1x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for FRONTEO

What Does FRONTEO's Recent Performance Look Like?

While the industry has experienced revenue growth lately, FRONTEO's revenue has gone into reverse gear, which is not great. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on analyst estimates for the company? Then our free report on FRONTEO will help you uncover what's on the horizon.

How Is FRONTEO's Revenue Growth Trending?

FRONTEO's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 18%. As a result, revenue from three years ago have also fallen 37% overall. 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 climb by 25% each year during the coming three years according to the sole analyst following the company. That's shaping up to be materially higher than the 6.1% per year growth forecast for the broader industry.

In light of this, it's understandable that FRONTEO's P/S sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

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

Shares in FRONTEO have seen a strong upwards swing lately, which has really helped boost its P/S figure. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that FRONTEO maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the IT industry, as expected. It appears that shareholders are confident in the company's future revenues, which is propping up the P/S. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you take the next step, you should know about the 1 warning sign for FRONTEO that we have uncovered.

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.