Despite an already strong run, Sea Limited (NYSE:SE) shares have been powering on, with a gain of 26% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 15% over that time.
Following the firm bounce in price, given close to half the companies operating in the United States' Entertainment industry have price-to-sales ratios (or "P/S") below 1.3x, you may consider Sea as a stock to potentially avoid with its 2.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.
How Sea Has Been Performing
With revenue growth that's inferior to most other companies of late, Sea has been relatively sluggish. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.
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Is There Enough Revenue Growth Forecasted For Sea?
The only time you'd be truly comfortable seeing a P/S as high as Sea's is when the company's growth is on track to outshine the industry.
Retrospectively, the last year delivered a decent 4.9% gain to the company's revenues. Pleasingly, revenue has also lifted 199% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.
Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 13% per year over the next three years. With the industry only predicted to deliver 9.7% per year, the company is positioned for a stronger revenue result.
In light of this, it's understandable that Sea's P/S sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
Sea's P/S is on the rise since its shares have risen strongly. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.
Our look into Sea shows that its P/S ratio remains high on the merit of its strong future revenues. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you take the next step, you should know about the 1 warning sign for Sea that we have uncovered.
If you're unsure about the strength of Sea'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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