There's Reason For Concern Over Mecaro Co., Ltd.'s (KOSDAQ:241770) Massive 26% Price Jump

Mecaro Co., Ltd. (KOSDAQ:241770) shares have continued their recent momentum with a 26% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 23% is also fairly reasonable.

Following the firm bounce in price, you could be forgiven for thinking Mecaro is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2x, considering almost half the companies in Korea's Semiconductor industry have P/S ratios below 1.3x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

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Check out our latest analysis for Mecaro

What Does Mecaro's Recent Performance Look Like?

Mecaro certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong 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.

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

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered an exceptional 63% gain to the company's top line. The latest three year period has also seen a 28% overall rise in revenue, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 33% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Mecaro's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

The Key Takeaway

Mecaro's P/S is on the rise since its shares have risen strongly. 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.

The fact that Mecaro currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Mecaro (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.

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