There wouldn't be many who think Alpha Group's (SZSE:002292) price-to-sales (or "P/S") ratio of 3.2x is worth a mention when the median P/S for the Leisure industry in China is similar at about 2.7x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

How Has Alpha Group Performed Recently?

Alpha Group certainly has been doing a good job lately as its revenue growth has been positive while most other companies have been seeing their revenue go backwards. Perhaps the market is expecting its current strong performance to taper off in accordance to the rest of the industry, which has kept the P/S contained. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

Do Revenue Forecasts Match The P/S Ratio?

The only time you'd be comfortable seeing a P/S like Alpha Group's is when the company's growth is tracking the industry closely.

If we review the last year of revenue growth, the company posted a worthy increase of 7.5%. The solid recent performance means it was also able to grow revenue by 9.6% 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.

Turning to the outlook, the next year should generate growth of 12% as estimated by the only analyst watching the company. Meanwhile, the rest of the industry is forecast to expand by 22%, which is noticeably more attractive.

With this information, we find it interesting that Alpha Group is trading at a fairly similar P/S compared to the industry. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

When you consider that Alpha Group's revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. A positive change is needed in order to justify the current price-to-sales ratio.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Alpha Group with six simple checks on some of these key factors.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com