Optimistic Investors Push Sourcenext Corporation (TSE:4344) Shares Up 40% But Growth Is Lacking

Sourcenext Corporation (TSE:4344) shares have had a really impressive month, gaining 40% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 14% over that time.

Although its price has surged higher, you could still be forgiven for feeling indifferent about Sourcenext's P/S ratio of 2.5x, since the median price-to-sales (or "P/S") ratio for the Software industry in Japan is also close to 2.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

See our latest analysis for Sourcenext

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

The recent revenue growth at Sourcenext would have to be considered satisfactory if not spectacular. One possibility is that the P/S is moderate because investors think this good revenue growth might only be parallel to the broader industry in the near future. If not, then at least existing shareholders probably aren't too pessimistic about the future direction of the share price.

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 Sourcenext's earnings, revenue and cash flow.

Is There Some Revenue Growth Forecasted For Sourcenext?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 4.9% last year. Still, lamentably revenue has fallen 21% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 15% shows it's an unpleasant look.

With this information, we find it concerning that Sourcenext is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

What Does Sourcenext's P/S Mean For Investors?

Sourcenext appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We find it unexpected that Sourcenext trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. Even though it matches the industry, we're uncomfortable with the current P/S ratio, as this dismal revenue performance is unlikely to support a more positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Sourcenext that you need to be mindful of.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.