Datasection Inc.'s (TSE:3905) 38% Price Boost Is Out Of Tune With Revenues

Despite an already strong run, Datasection Inc. (TSE:3905) shares have been powering on, with a gain of 38% in the last thirty days. The last month tops off a massive increase of 227% in the last year.

Since its price has surged higher, you could be forgiven for thinking Datasection is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.5x, considering almost half the companies in Japan's Software industry have P/S ratios below 2.1x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Datasection

How Datasection Has Been Performing

Datasection has been doing a good job lately as it's been growing revenue at a solid pace. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Datasection will help you shine a light on its historical performance.

How Is Datasection's Revenue Growth Trending?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 14% last year. The latest three year period has also seen an excellent 57% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Weighing that recent medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 15% shows it's about the same on an annualised basis.

In light of this, it's curious that Datasection's P/S sits above the majority of other companies. Apparently many investors in the company are more bullish than recent times would indicate and aren't willing to let go of their stock right now. Nevertheless, they may be setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Bottom Line On Datasection's P/S

Shares in Datasection have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 didn't expect to see Datasection trade at such a high P/S considering its last three-year revenue growth has only been on par with the rest of the industry. When we see average revenue with industry-like growth combined with a high P/S, we suspect the share price is at risk of declining, bringing the P/S back in line with the industry too. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 3 warning signs for Datasection you should be aware of, and 2 of them shouldn't be ignored.

If you're unsure about the strength of Datasection'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.