Datasection Inc.'s (TSE:3905) 89% Share Price Surge Not Quite Adding Up

Datasection Inc. (TSE:3905) shares have continued their recent momentum with a 89% gain in the last month alone. This latest share price bounce rounds out a remarkable 569% gain over the last twelve months.

After such a large jump in price, given around half the companies in Japan's Software industry have price-to-sales ratios (or "P/S") below 2.2x, you may consider Datasection as a stock to avoid entirely with its 13.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Datasection

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

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?

Datasection'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.

If we review the last year of revenue growth, the company posted a worthy increase of 14%. This was backed up an excellent period prior to see revenue up by 57% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

It's interesting to note that the rest of the industry is similarly expected to grow by 15% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this information, we find it interesting that Datasection is trading at a high P/S compared to the industry. 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. Although, additional gains will be difficult to achieve as a continuation of recent revenue trends would weigh down the share price eventually.

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

The strong share price surge has lead to Datasection's P/S soaring as well. 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 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. Unless there is a significant improvement in the company's medium-term trends, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It is also worth noting that we have found 3 warning signs for Datasection (2 are concerning!) that you need to take into consideration.

If these risks are making you reconsider your opinion on Datasection, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.