What Serko Limited's (NZSE:SKO) 26% Share Price Gain Is Not Telling You

Serko Limited (NZSE:SKO) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 6.4% over the last year.

After such a large jump in price, Serko's price-to-sales (or "P/S") ratio of 6.7x might make it look like a strong sell right now compared to other companies in the Software industry in New Zealand, where around half of the companies have P/S ratios below 3.5x and even P/S below 1.1x are quite common. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Serko

What Does Serko's Recent Performance Look Like?

Recent times have been advantageous for Serko as its revenues have been rising faster than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. 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 Serko will help you uncover what's on the horizon.

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

In order to justify its P/S ratio, Serko would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 48%. Spectacularly, three year revenue growth has ballooned by several orders of magnitude, thanks in part to the last 12 months of revenue growth. Accordingly, shareholders would have been over the moon with those medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 21% each year during the coming three years according to the seven analysts following the company. With the industry predicted to deliver 20% growth per year, the company is positioned for a comparable revenue result.

With this in consideration, we find it intriguing that Serko's P/S is higher than its industry peers. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Serko's P/S

The strong share price surge has lead to Serko's P/S soaring as well. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Serko currently trades on a higher than expected P/S. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. A positive change is needed in order to justify the current price-to-sales ratio.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Serko you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com