Forgame Holdings Limited (HKG:484) shareholders would be excited to see that the share price has had a great month, posting a 38% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 8.8% isn't as impressive.

Although its price has surged higher, it's still not a stretch to say that Forgame Holdings' price-to-sales (or "P/S") ratio of 1.5x right now seems quite "middle-of-the-road" compared to the Entertainment industry in Hong Kong, where the median P/S ratio is around 1.7x. 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.

What Does Forgame Holdings' Recent Performance Look Like?

For example, consider that Forgame Holdings' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 28%. This means it has also seen a slide in revenue over the longer-term as revenue is down 39% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 36% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's somewhat alarming that Forgame Holdings' P/S sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 the recent negative growth rates.

What We Can Learn From Forgame Holdings' P/S?

Forgame Holdings appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry 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.

The fact that Forgame Holdings currently trades at a P/S on par with the rest of the industry is surprising to us since its recent revenues have been in decline over the medium-term, all while the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Forgame Holdings that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.