When close to half the companies in the Entertainment industry in Hong Kong have price-to-sales ratios (or "P/S") below 1.8x, you may consider XD Inc. (HKG:2400) as a stock to potentially avoid with its 3.3x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for XD

How Has XD Performed Recently?

With revenue growth that's superior to most other companies of late, XD has been doing relatively well. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. If not, then existing shareholders might be a little nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

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

Taking a look back first, we see that the company grew revenue by an impressive 27% last year. Revenue has also lifted 21% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest revenue should grow by 21% per year over the next three years. That's shaping up to be similar to the 21% per year growth forecast for the broader industry.

With this information, we find it interesting that XD is trading at a high P/S compared to the industry. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Final Word

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Analysts are forecasting XD's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. A positive change is needed in order to justify the current price-to-sales ratio.

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

If you're unsure about the strength of XD'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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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.