Sky Blue 11 Company Limited (HKG:1010) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 41% over that time.

Since its price has surged higher, you could be forgiven for thinking Sky Blue 11 is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2x, considering almost half the companies in Hong Kong's Semiconductor industry have P/S ratios below 1.2x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Sky Blue 11 Has Been Performing

As an illustration, revenue has deteriorated at Sky Blue 11 over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

There's an inherent assumption that a company should outperform the industry for P/S ratios like Sky Blue 11's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 37%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 23% in total. 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 the recent medium-term revenue trends against the industry's one-year growth forecast of 13% shows it's noticeably less attractive.

With this information, we find it concerning that Sky Blue 11 is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Final Word

Sky Blue 11's P/S is on the rise since its shares have risen strongly. 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.

Our examination of Sky Blue 11 revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Sky Blue 11 (1 makes us a bit uncomfortable) you should be aware of.

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).

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