There's Reason For Concern Over Synlait Milk Limited's (NZSE:SML) Massive 26% Price Jump

Despite an already strong run, Synlait Milk Limited (NZSE:SML) shares have been powering on, with a gain of 26% in the last thirty days. The last 30 days bring the annual gain to a very sharp 35%.

In spite of the firm bounce in price, it's still not a stretch to say that Synlait Milk's price-to-sales (or "P/S") ratio of 0.4x right now seems quite "middle-of-the-road" compared to the Food industry in New Zealand, where the median P/S ratio is around 0.6x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Check out our latest analysis for Synlait Milk

How Has Synlait Milk Performed Recently?

Synlait Milk's revenue growth of late has been pretty similar to most other companies. It seems that many are expecting the mediocre revenue performance to persist, which has held the P/S ratio back. If this is the case, then at least existing shareholders won't be losing sleep over the current share price.

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

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

The only time you'd be comfortable seeing a P/S like Synlait Milk's is when the company's growth is tracking the industry closely.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. Regardless, revenue has managed to lift by a handy 20% in aggregate from three years ago, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 4.0% per annum during the coming three years according to the six analysts following the company. That's shaping up to be materially lower than the 7.5% per annum growth forecast for the broader industry.

In light of this, it's curious that Synlait Milk's P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Synlait Milk's P/S Mean For Investors?

Synlait Milk appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

When you consider that Synlait Milk's revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about these 3 warning signs we've spotted with Synlait Milk.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.