Broadleaf Co., Ltd. (TSE:3673) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Broadleaf Co., Ltd. (TSE:3673) shareholders are no doubt pleased to see that the share price has bounced 25% in the last month, although it is still struggling to make up recently lost ground. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

After such a large jump in price, you could be forgiven for thinking Broadleaf is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.6x, considering almost half the companies in Japan's Software industry have P/S ratios below 2x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Broadleaf

How Has Broadleaf Performed Recently?

Broadleaf has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. However, if this isn't the case, investors might get caught out paying too much for the stock.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Broadleaf's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

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

If we review the last year of revenue growth, the company posted a worthy increase of 14%. Still, lamentably revenue has fallen 18% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 12% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Broadleaf's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Broadleaf's P/S is on the rise since its shares have risen strongly. 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.

Our examination of Broadleaf revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - Broadleaf has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.