Sourcenext Corporation (TSE:4344) Investors Are Less Pessimistic Than Expected

When you see that almost half of the companies in the Software industry in Japan have price-to-sales ratios (or "P/S") below 2x, Sourcenext Corporation (TSE:4344) looks to be giving off some sell signals with its 2.6x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Sourcenext

What Does Sourcenext's Recent Performance Look Like?

The revenue growth achieved at Sourcenext over the last year would be more than acceptable for most companies. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Enough Revenue Growth Forecasted For Sourcenext?

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

Retrospectively, the last year delivered a decent 9.3% gain to the company's revenues. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 7.4% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 12% shows it's an unpleasant look.

In light of this, it's alarming that Sourcenext'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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

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

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Sourcenext 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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 should always think about risks. Case in point, we've spotted 1 warning sign for Sourcenext you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.