When close to half the companies in the Entertainment industry in Hong Kong have price-to-sales ratios (or "P/S") below 1.7x, you may consider Cloud Music Inc. (HKG:9899) as a stock to potentially avoid with its 2.4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Cloud Music's Recent Performance Look Like?

Cloud Music could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Cloud Music?

In order to justify its P/S ratio, Cloud Music would need to produce impressive growth in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 13%. Even so, admirably revenue has lifted 61% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 8.1% each year as estimated by the ten analysts watching the company. With the industry predicted to deliver 18% growth per year, the company is positioned for a weaker revenue result.

With this in consideration, we believe it doesn't make sense that Cloud Music'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. 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.

What Does Cloud Music's P/S Mean For Investors?

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 Cloud Music trade at such a high P/S given the revenue forecasts look less than stellar. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. At these price levels, investors should remain cautious, particularly if things don't improve.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Cloud Music with six simple checks will allow you to discover any risks that could be an issue.

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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