There's Reason For Concern Over Electromagnetica S.A.'s (BVB:ELMA) Massive 27% Price Jump

Electromagnetica S.A. (BVB:ELMA) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 19% is also fairly reasonable.

Even after such a large jump in price, there still wouldn't be many who think Electromagnetica's price-to-sales (or "P/S") ratio of 1.2x is worth a mention when the median P/S in Romania's Electronic industry is similar at about 1x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

Check out our latest analysis for Electromagnetica

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

For instance, Electromagnetica's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is moderate because investors think the company might still do enough to be in line with the broader industry in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

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 Electromagnetica's earnings, revenue and cash flow.

How Is Electromagnetica's Revenue Growth Trending?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Electromagnetica'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 38%. The last three years don't look nice either as the company has shrunk revenue by 57% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 9.2% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Electromagnetica's P/S exceeds that of its industry peers. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

The Key Takeaway

Its shares have lifted substantially and now Electromagnetica's P/S is back within range of the industry median. 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.

We find it unexpected that Electromagnetica trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. Even though it matches the industry, we're uncomfortable with the current P/S ratio, as this dismal revenue performance is unlikely to support a more positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you settle on your opinion, we've discovered 2 warning signs for Electromagnetica (1 makes us a bit uncomfortable!) that you should be aware of.

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.