Forside Co.,Ltd.'s (TSE:2330) 27% Share Price Plunge Could Signal Some Risk

Forside Co.,Ltd. (TSE:2330) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. The good news is that in the last year, the stock has shone bright like a diamond, gaining 160%.

Although its price has dipped substantially, you could still be forgiven for feeling indifferent about ForsideLtd's P/S ratio of 1.7x, since the median price-to-sales (or "P/S") ratio for the Software industry in Japan is also close to 2x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Check out our latest analysis for ForsideLtd

How ForsideLtd Has Been Performing

As an illustration, revenue has deteriorated at ForsideLtd over the last year, which is not ideal at all. Perhaps investors believe the recent revenue performance is enough to keep in line with the industry, which is keeping the P/S from dropping off. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

What Are Revenue Growth Metrics Telling Us About The P/S?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 4.8%. 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. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 13% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's curious that ForsideLtd's 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.

What We Can Learn From ForsideLtd's P/S?

ForsideLtd's plummeting stock price has brought its P/S back to a similar region as the rest of the industry. 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.

Our examination of ForsideLtd revealed its poor three-year revenue trends aren't resulting in a lower P/S as per our expectations, given they look worse than current industry outlook. 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 ForsideLtd (1 is concerning!) that you need to be mindful 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.