Zhihu Inc. (NYSE:ZH) Might Not Be As Mispriced As It Looks

Zhihu Inc.'s (NYSE:ZH) price-to-sales (or "P/S") ratio of 0.9x might make it look like a buy right now compared to the Interactive Media and Services industry in the United States, where around half of the companies have P/S ratios above 1.7x and even P/S above 4x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

Check out our latest analysis for Zhihu

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

Zhihu certainly has been doing a good job lately as it's been growing revenue more than most other companies. One possibility is that the P/S ratio is low because investors think this strong revenue performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Zhihu.

Do Revenue Forecasts Match The Low P/S Ratio?

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

If we review the last year of revenue growth, the company posted a terrific increase of 19%. The latest three year period has also seen an excellent 295% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 15% per annum as estimated by the nine analysts watching the company. That's shaping up to be materially higher than the 12% each year growth forecast for the broader industry.

In light of this, it's peculiar that Zhihu's P/S sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Key Takeaway

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.

A look at Zhihu's revenues reveals that, despite glowing future growth forecasts, its P/S is much lower than we'd expect. When we see strong growth forecasts like this, we can only assume potential risks are what might be placing significant pressure on the P/S ratio. It appears the market could be anticipating revenue instability, because these conditions should normally provide a boost to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Zhihu with six simple checks will allow you to discover any risks that could be an issue.

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.