Kunlun Tech Co., Ltd.'s (SZSE:300418) price-to-sales (or "P/S") ratio of 8.7x might make it look like a sell right now compared to the Entertainment industry in China, where around half of the companies have P/S ratios below 6.1x and even P/S below 3x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Kunlun Tech

What Does Kunlun Tech's P/S Mean For Shareholders?

With revenue growth that's superior to most other companies of late, Kunlun Tech has been doing relatively well. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. If not, then existing shareholders might be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Kunlun Tech?

The only time you'd be truly comfortable seeing a P/S as high as Kunlun Tech's is when the company's growth is on track to outshine the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 7.2% last year. Pleasingly, revenue has also lifted 32% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenues over that time.

Looking ahead now, revenue is anticipated to climb by 9.7% during the coming year according to the four analysts following the company. That's shaping up to be materially lower than the 37% growth forecast for the broader industry.

With this information, we find it concerning that Kunlun Tech is trading at a P/S higher than the industry. 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

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.

We've concluded that Kunlun Tech 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 3 warning signs for Kunlun Tech (1 is a bit concerning) 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.