Microchip Technology Incorporated's (NASDAQ:MCHP) 25% Share Price Surge Not Quite Adding Up

Those holding Microchip Technology Incorporated (NASDAQ:MCHP) shares would be relieved that the share price has rebounded 25% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 41% in the last twelve months.

Following the firm bounce in price, Microchip Technology may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 7.2x, since almost half of all companies in the Semiconductor industry in the United States have P/S ratios under 3.7x and even P/S lower than 1.6x are not unusual. 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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Check out our latest analysis for Microchip Technology

How Has Microchip Technology Performed Recently?

While the industry has experienced revenue growth lately, Microchip Technology's revenue has gone into reverse gear, which is not great. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

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

Retrospectively, the last year delivered a frustrating 42% decrease to the company's top line. As a result, revenue from three years ago have also fallen 35% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Looking ahead now, revenue is anticipated to climb by 13% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 24% per annum, which is noticeably more attractive.

With this in consideration, we believe it doesn't make sense that Microchip Technology's P/S is outpacing its industry peers. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

Shares in Microchip Technology have seen a strong upwards swing lately, which has really helped boost its P/S figure. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

It comes as a surprise to see Microchip Technology 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Microchip Technology you should be aware of, and 2 of them can't be ignored.

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.