What Salcon Berhad's (KLSE:SALCON) 33% Share Price Gain Is Not Telling You

Salcon Berhad (KLSE:SALCON) shareholders would be excited to see that the share price has had a great month, posting a 33% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 42% in the last year.

After such a large jump in price, when almost half of the companies in Malaysia's Water Utilities industry have price-to-sales ratios (or "P/S") below 1.4x, you may consider Salcon Berhad as a stock probably not worth researching with its 2x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Salcon Berhad

How Has Salcon Berhad Performed Recently?

For example, consider that Salcon Berhad's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

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 Salcon Berhad's earnings, revenue and cash flow.

How Is Salcon Berhad's Revenue Growth Trending?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Salcon Berhad'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 24%. The last three years don't look nice either as the company has shrunk revenue by 21% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 11% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Salcon Berhad'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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Salcon Berhad's P/S is on the rise since its shares have risen strongly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Salcon Berhad currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Salcon Berhad (1 doesn't sit too well with us) you should be aware of.

If you're unsure about the strength of Salcon Berhad's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.