There's Reason For Concern Over Broadleaf Co., Ltd.'s (TSE:3673) Massive 28% Price Jump

Broadleaf Co., Ltd. (TSE:3673) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 24% is also fairly reasonable.

After such a large jump in price, given close to half the companies operating in Japan's Software industry have price-to-sales ratios (or "P/S") below 1.9x, you may consider Broadleaf as a stock to potentially avoid with its 3.5x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

We've discovered 2 warning signs about Broadleaf. View them for free.

View our latest analysis for Broadleaf

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

Revenue has risen firmly for Broadleaf recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. 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 Broadleaf, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Broadleaf's Revenue Growth Trending?

In order to justify its P/S ratio, Broadleaf would need to produce impressive growth in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 17%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 13% drop in revenue in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 12% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Broadleaf's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Final Word

Broadleaf shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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.

We've established that Broadleaf currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

Before you take the next step, you should know about the 2 warning signs for Broadleaf (1 can't be ignored!) that we have uncovered.

If you're unsure about the strength of Broadleaf's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.