Silicom Ltd. (NASDAQ:SILC) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 8.7% over the last year.

Although its price has surged higher, you could still be forgiven for feeling indifferent about Silicom's P/S ratio of 1.6x, since the median price-to-sales (or "P/S") ratio for the Communications industry in the United States is also close to 1.2x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

How Has Silicom Performed Recently?

Silicom hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. Perhaps the market is expecting its poor revenue performance to improve, keeping the P/S from dropping. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

In order to justify its P/S ratio, Silicom would need to produce growth that's similar to the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 59%. The last three years don't look nice either as the company has shrunk revenue by 51% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Looking ahead now, revenue is anticipated to slump, contracting by 3.7% during the coming year according to the only analyst following the company. That's not great when the rest of the industry is expected to grow by 11%.

With this information, we find it concerning that Silicom is trading at a fairly similar P/S compared to the industry. 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 negative growth outlook.

The Bottom Line On Silicom's P/S

Its shares have lifted substantially and now Silicom's P/S is back within range of the industry median. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

It appears that Silicom currently trades on a higher than expected P/S for a company whose revenues are forecast to decline. When we see a gloomy outlook like this, our immediate thoughts are that the share price is at risk of declining, negatively impacting P/S. If we consider the revenue outlook, the P/S seems to indicate that potential investors may be paying a premium for the stock.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Silicom, and understanding should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.