Alco Holdings Limited (HKG:328) shareholders won't be pleased to see that the share price has had a very rough month, dropping 56% and undoing the prior period's positive performance. The good news is that in the last year, the stock has shone bright like a diamond, gaining 213%.

Although its price has dipped substantially, given around half the companies in Hong Kong's Consumer Durables industry have price-to-sales ratios (or "P/S") below 0.5x, you may still consider Alco Holdings as a stock to avoid entirely with its 2.7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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

Recent times have been quite advantageous for Alco Holdings as its revenue has been rising very briskly. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

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

If we review the last year of revenue growth, the company posted a terrific increase of 66%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 88% drop in revenue in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 13% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Alco Holdings is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

What We Can Learn From Alco Holdings' P/S?

Even after such a strong price drop, Alco Holdings' P/S still exceeds the industry median significantly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Alco Holdings currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Alco Holdings is showing 5 warning signs in our investment analysis, and 4 of those can't be ignored.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

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