When you see that almost half of the companies in the Entertainment industry in Hong Kong have price-to-sales ratios (or "P/S") below 1.8x, Digital Domain Holdings Limited (HKG:547) looks to be giving off strong sell signals with its 3.9x 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 so lofty.

What Does Digital Domain Holdings' P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Digital Domain Holdings over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Digital Domain Holdings would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a frustrating 23% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 22% overall rise in revenue. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 20% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Digital Domain Holdings' P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

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.

The fact that Digital Domain Holdings currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You need to take note of risks, for example - Digital Domain Holdings has 2 warning signs (and 1 which is concerning) we think you should know about.

If these risks are making you reconsider your opinion on Digital Domain Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.