The 7Road Holdings Limited (HKG:797) share price has done very well over the last month, posting an excellent gain of 38%. Notwithstanding the latest gain, the annual share price return of 9.0% isn't as impressive.

Following the firm bounce in price, when almost half of the companies in Hong Kong's Entertainment industry have price-to-sales ratios (or "P/S") below 1.8x, you may consider 7Road Holdings as a stock not worth researching with its 12.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has 7Road Holdings Performed Recently?

7Road Holdings has been doing a good job lately as it's been growing revenue at a solid pace. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be 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.

Is There Enough Revenue Growth Forecasted For 7Road Holdings?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like 7Road Holdings' to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 16%. Pleasingly, revenue has also lifted 48% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 21% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that 7Road Holdings' P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates 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 recent growth rates.

The Key Takeaway

The strong share price surge has lead to 7Road Holdings' P/S soaring as well. 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 7Road 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. 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

And what about other risks? Every company has them, and we've spotted 1 warning sign for 7Road Holdings you should know about.

If you're unsure about the strength of 7Road Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

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