Digital Garage, Inc. (TSE:4819) Stocks Shoot Up 27% But Its P/S Still Looks Reasonable

Digital Garage, Inc. (TSE:4819) shareholders have had their patience rewarded with a 27% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 25%.

After such a large jump in price, given around half the companies in Japan's IT industry have price-to-sales ratios (or "P/S") below 1.1x, you may consider Digital Garage as a stock to avoid entirely with its 6.2x 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.

View our latest analysis for Digital Garage

How Digital Garage Has Been Performing

Digital Garage hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. It might be that many expect the dour revenue performance to recover substantially, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Digital Garage.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 11%. The last three years don't look nice either as the company has shrunk revenue by 37% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Shifting to the future, estimates from the dual analysts covering the company suggest revenue should grow by 40% over the next year. With the industry only predicted to deliver 6.6%, the company is positioned for a stronger revenue result.

In light of this, it's understandable that Digital Garage's P/S sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

Digital Garage's P/S has grown nicely over the last month thanks to a handy boost in the share price. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Digital Garage maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the IT industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

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

If these risks are making you reconsider your opinion on Digital Garage, 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.