Merit Interactive Co.,Ltd.'s (SZSE:300766) price-to-sales (or "P/S") ratio of 14.9x might make it look like a strong sell right now compared to the IT industry in China, where around half of the companies have P/S ratios below 4.5x and even P/S below 2x are quite common. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Merit InteractiveLtd

What Does Merit InteractiveLtd's P/S Mean For Shareholders?

Merit InteractiveLtd could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Merit InteractiveLtd?

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

Retrospectively, the last year delivered a frustrating 20% decrease to the company's top line. As a result, revenue from three years ago have also fallen 10% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Shifting to the future, estimates from the one analyst covering the company suggest revenue should grow by 40% over the next year. That's shaping up to be materially lower than the 50% growth forecast for the broader industry.

With this in consideration, we believe it doesn't make sense that Merit InteractiveLtd's P/S is outpacing its industry peers. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

What Does Merit InteractiveLtd's P/S Mean For Investors?

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've concluded that Merit InteractiveLtd currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 6 warning signs for Merit InteractiveLtd that you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.