Unpleasant Surprises Could Be In Store For Prefab S.A.'s (BVB:PREH) Shares

Prefab S.A.'s (BVB:PREH) price-to-sales (or "P/S") ratio of 1.6x may not look like an appealing investment opportunity when you consider close to half the companies in the Basic Materials industry in Romania have P/S ratios below 0.8x. 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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View our latest analysis for Prefab

What Does Prefab's Recent Performance Look Like?

For example, consider that Prefab'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. 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 Prefab, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Prefab?

Prefab's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 24% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

It turns out the industry is also predicted to shrink 8.1% in the next 12 months, mirroring the company's downward momentum based on recent medium-term annualised revenue results.

With this in mind, we find it a bit intriguing that Prefab's P/S exceeds that of its industry peers. With revenue going in reverse, it's not guaranteed that the P/S has found a floor yet. There's strong potential for the P/S to fall to lower levels if the company doesn't improve its top-line growth, which would be difficult to do with the current industry outlook.

The Key Takeaway

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.

Our examination of Prefab revealed its three-year contraction in revenue growth isn't impacting its high P/S as much as we would have predicted, given the industry is set to shrink at a similar rate. At present, we find the high P/S concerning, as we do not believe that the current revenue performance can sustain such optimistic market sentiment for an extended period. In addition, we are concerned whether the company can maintain its medium-term level of performance under these tough industry conditions. Unless the company's relative performance improves, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Prefab (1 is significant!) that you need to take into consideration.

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.