The HG Semiconductor Limited (HKG:6908) share price has softened a substantial 26% over the previous 30 days, handing back much of the gains the stock has made lately. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 24% in that time.

Although its price has dipped substantially, you could still be forgiven for thinking HG Semiconductor is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.1x, considering almost half the companies in Hong Kong's Semiconductor industry have P/S ratios below 1.4x. 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 HG Semiconductor Performed Recently?

For instance, HG Semiconductor's receding revenue in recent times would have to be some food for thought. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is HG Semiconductor's Revenue Growth Trending?

HG Semiconductor's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a frustrating 14% decrease to the company's top line. As a result, revenue from three years ago have also fallen 50% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 18% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that HG Semiconductor's P/S sits above 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. 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

Even after such a strong price drop, HG Semiconductor's P/S still exceeds the industry median significantly. 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 HG Semiconductor 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with HG Semiconductor (at least 2 which are concerning), and understanding them should be part of your investment process.

If you're unsure about the strength of HG Semiconductor's 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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