The Fire Rock Holdings Limited (HKG:1909) share price has done very well over the last month, posting an excellent gain of 67%. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.8% over the last year.

After such a large jump in price, you could be forgiven for thinking Fire Rock Holdings is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.1x, considering almost half the companies in Hong Kong's Entertainment industry have P/S ratios below 1.7x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Fire Rock Holdings' P/S Mean For Shareholders?

Fire Rock Holdings has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Fire Rock Holdings' Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Fire Rock Holdings' to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 4.9%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 83% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 35% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Fire Rock Holdings' P/S exceeds that of its industry peers. 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 very 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.

The Final Word

Fire Rock Holdings' P/S has grown nicely over the last month thanks to a handy boost in the share price. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Fire Rock Holdings revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Fire Rock Holdings is showing 2 warning signs in our investment analysis, and 1 of those is potentially serious.

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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