Sourcenext Corporation's (TSE:4344) 32% Share Price Plunge Could Signal Some Risk

Sourcenext Corporation (TSE:4344) shares have retraced a considerable 32% in the last month, reversing a fair amount of their solid recent performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 19% in that time.

Even after such a large drop in price, you could still be forgiven for feeling indifferent about Sourcenext's P/S ratio of 2.3x, since the median price-to-sales (or "P/S") ratio for the Software industry in Japan is also close to 2.1x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

See our latest analysis for Sourcenext

How Sourcenext Has Been Performing

Sourcenext has been doing a decent job lately as it's been growing revenue at a reasonable pace. Perhaps the expectation moving forward is that the revenue growth will track in line with the wider industry for the near term, which has kept the P/S subdued. Those who are bullish on Sourcenext will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

Although there are no analyst estimates available for Sourcenext, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Sourcenext's Revenue Growth Trending?

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

Retrospectively, the last year delivered a decent 4.9% gain to the company's revenues. However, this wasn't enough as the latest three year period has seen an unpleasant 21% overall drop in revenue. 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 14% shows it's an unpleasant look.

In light of this, it's somewhat alarming that Sourcenext's P/S sits in line with 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 on the share price eventually.

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

Following Sourcenext's share price tumble, its P/S is just clinging on to the industry median P/S. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

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. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Sourcenext, and understanding them should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.