Further Upside For AoFrio Limited (NZSE:AOF) Shares Could Introduce Price Risks After 31% Bounce

AoFrio Limited (NZSE:AOF) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 24% in the last twelve months.

In spite of the firm bounce in price, AoFrio may still be sending bullish signals at the moment with its price-to-sales (or "P/S") ratio of 0.4x, since almost half of all companies in the Electrical industry in New Zealand have P/S ratios greater than 1x and even P/S higher than 6x are not unusual. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for AoFrio

What Does AoFrio's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at AoFrio over the last year, which is not ideal at all. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Although there are no analyst estimates available for AoFrio, 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 Low P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as low as AoFrio's is when the company's growth is on track to lag the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 10%. Still, the latest three year period has seen an excellent 80% overall rise in revenue, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the industry, which is expected to grow by 15% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we find it odd that AoFrio is trading at a P/S lower than the industry. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Key Takeaway

AoFrio's stock price has surged recently, but its but its P/S still remains modest. 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.

Our examination of AoFrio revealed its three-year revenue trends aren't boosting its P/S anywhere near as much as we would have predicted, given they look better than current industry expectations. When we see strong revenue with faster-than-industry growth, we assume there are some significant underlying risks to the company's ability to make money which is applying downwards pressure on the P/S ratio. While recent revenue trends over the past medium-term suggest that the risk of a price decline is low, investors appear to perceive a likelihood of revenue fluctuations in the future.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with AoFrio, and understanding these 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.