Unpleasant Surprises Could Be In Store For Alibaba Group Holding Limited's (NYSE:BABA) Shares

When close to half the companies in the Multiline Retail industry in the United States have price-to-sales ratios (or "P/S") below 0.6x, you may consider Alibaba Group Holding Limited (NYSE:BABA) as a stock to potentially avoid with its 1.5x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

View our latest analysis for Alibaba Group Holding

What Does Alibaba Group Holding's P/S Mean For Shareholders?

Recent times haven't been great for Alibaba Group Holding as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

What Are Revenue Growth Metrics Telling Us About The High P/S?

The only time you'd be truly comfortable seeing a P/S as high as Alibaba Group Holding's is when the company's growth is on track to outshine the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 6.5%. Pleasingly, revenue has also lifted 57% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 8.6% each year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 14% per year growth forecast for the broader industry.

With this in consideration, we believe it doesn't make sense that Alibaba Group Holding's P/S is outpacing its industry peers. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Final Word

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.

It comes as a surprise to see Alibaba Group Holding trade at such a high P/S given the revenue forecasts look less than stellar. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. At these price levels, investors should remain cautious, particularly if things don't improve.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Alibaba Group Holding with six simple checks will allow you to discover any risks that could be an issue.

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.