Promise Technology, Inc.'s (TWSE:3057) 28% Share Price Surge Not Quite Adding Up

Promise Technology, Inc. (TWSE:3057) shares have had a really impressive month, gaining 28% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 26%.

Since its price has surged higher, you could be forgiven for thinking Promise Technology is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.4x, considering almost half the companies in Taiwan's Tech industry have P/S ratios below 1.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

See our latest analysis for Promise Technology

What Does Promise Technology's P/S Mean For Shareholders?

For example, consider that Promise Technology's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Promise Technology's earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Promise Technology?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Promise Technology's to be considered reasonable.

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 26%. As a result, revenue from three years ago have also fallen 35% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 29% 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 Promise Technology's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Final Word

The large bounce in Promise Technology's shares has lifted the company's P/S handsomely. 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.

We've established that Promise Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Before you take the next step, you should know about the 1 warning sign for Promise Technology that we have uncovered.

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.