Santech Holdings Limited's (NASDAQ:STEC) 53% Share Price Plunge Could Signal Some Risk

Santech Holdings Limited (NASDAQ:STEC) shares have retraced a considerable 53% in the last month, reversing a fair amount of their solid recent performance. The good news is that in the last year, the stock has shone bright like a diamond, gaining 281%.

Although its price has dipped substantially, Santech Holdings' price-to-sales (or "P/S") ratio of 11.2x might still make it look like a strong sell right now compared to other companies in the Capital Markets industry in the United States, where around half of the companies have P/S ratios below 4x and even P/S below 1.9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

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View our latest analysis for Santech Holdings

How Santech Holdings Has Been Performing

As an illustration, revenue has deteriorated at Santech Holdings over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

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 Santech Holdings' earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a frustrating 96% decrease to the company's top line. As a result, revenue from three years ago have also fallen 96% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 10% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Santech Holdings' P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On Santech Holdings' P/S

A significant share price dive has done very little to deflate Santech Holdings' very lofty P/S. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Santech Holdings currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Santech Holdings that you need to be mindful of.

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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.