GDS Holdings Limited's (NASDAQ:GDS) Shares Climb 27% But Its Business Is Yet to Catch Up

GDS Holdings Limited (NASDAQ:GDS) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The annual gain comes to 225% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, given close to half the companies operating in the United States' IT industry have price-to-sales ratios (or "P/S") below 2.7x, you may consider GDS Holdings as a stock to potentially avoid with its 4.1x 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.

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Check out our latest analysis for GDS Holdings

What Does GDS Holdings' P/S Mean For Shareholders?

With revenue growth that's inferior to most other companies of late, GDS Holdings has been relatively sluggish. Perhaps the market is expecting future revenue performance to undergo a reversal of fortunes, which has elevated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a decent 8.2% gain to the company's revenues. The solid recent performance means it was also able to grow revenue by 27% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 14% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 23% per annum, which is noticeably more attractive.

With this information, we find it concerning that GDS Holdings is trading at a P/S higher than the industry. 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 Bottom Line On GDS Holdings' P/S

GDS Holdings shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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 GDS Holdings 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for GDS Holdings (1 doesn't sit too well with us) you should be aware of.

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.