Those holding Ares Asia Limited (HKG:645) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 57% share price drop in the last twelve months.

Even after such a large jump in price, it's still not a stretch to say that Ares Asia's price-to-sales (or "P/S") ratio of 0.1x right now seems quite "middle-of-the-road" compared to the Trade Distributors industry in Hong Kong, where the median P/S ratio is around 0.5x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

How Has Ares Asia Performed Recently?

Recent times have been quite advantageous for Ares Asia as its revenue has been rising very briskly. The P/S is probably moderate because investors think this strong revenue growth might not be enough to outperform the broader industry in the near future. Those who are bullish on Ares Asia will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

Do Revenue Forecasts Match The P/S Ratio?

Ares Asia's P/S ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the industry.

Retrospectively, the last year delivered an exceptional 41% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 28% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's somewhat alarming that Ares Asia's P/S sits in line with 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 on the share price eventually.

The Key Takeaway

Ares Asia's stock has a lot of momentum behind it lately, which has brought its P/S level with the rest of the industry. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our look at Ares Asia revealed its shrinking revenues over the medium-term haven't impacted the P/S as much as we anticipated, given the industry is set to grow. Even though it matches the industry, we're uncomfortable with the current P/S ratio, as this dismal revenue performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You should always think about risks. Case in point, we've spotted 4 warning signs for Ares Asia 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.