SM Entertainment Co., Ltd.'s (KOSDAQ:041510) Shares Climb 25% But Its Business Is Yet to Catch Up

SM Entertainment Co., Ltd. (KOSDAQ:041510) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 20% is also fairly reasonable.

After such a large jump in price, given close to half the companies operating in Korea's Entertainment industry have price-to-sales ratios (or "P/S") below 1.5x, you may consider SM Entertainment as a stock to potentially avoid with its 2.1x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for SM Entertainment

How Has SM Entertainment Performed Recently?

SM Entertainment 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Want the full picture on analyst estimates for the company? Then our free report on SM Entertainment will help you uncover what's on the horizon.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as SM Entertainment's is when the company's growth is on track to outshine the industry.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. Still, the latest three year period has seen an excellent 45% overall rise in revenue, in spite of its uninspiring short-term performance. Accordingly, shareholders will be pleased, but also have some questions to ponder about the last 12 months.

Looking ahead now, revenue is anticipated to climb by 12% during the coming year according to the analysts following the company. That's shaping up to be materially lower than the 15% growth forecast for the broader industry.

With this information, we find it concerning that SM Entertainment is trading at a P/S higher than the industry. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Final Word

The large bounce in SM Entertainment's shares has lifted the company's P/S handsomely. 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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for SM Entertainment, this doesn't appear to be impacting the P/S in the slightest. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - SM Entertainment has 1 warning sign we think 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.