Some Confidence Is Lacking In Digital Domain Holdings Limited (HKG:547) As Shares Slide 27%

Digital Domain Holdings Limited (HKG:547) shares have had a horrible month, losing 27% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 39% in that time.

Although its price has dipped substantially, given close to half the companies operating in Hong Kong's Entertainment industry have price-to-sales ratios (or "P/S") below 1.7x, you may still consider Digital Domain Holdings as a stock to potentially avoid with its 3.1x 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.

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Check out our latest analysis for Digital Domain Holdings

What Does Digital Domain Holdings' Recent Performance Look Like?

Recent times have been quite advantageous for Digital Domain Holdings as its revenue has been rising very briskly. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. 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?

In order to justify its P/S ratio, Digital Domain Holdings would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered an exceptional 32% 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 17% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

In contrast to the company, the rest of the industry is expected to grow by 10% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Digital Domain Holdings' P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Despite the recent share price weakness, Digital Domain Holdings' P/S remains higher than most other companies in the industry. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Digital Domain Holdings revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It is also worth noting that we have found 2 warning signs for Digital Domain Holdings (1 is a bit unpleasant!) that you need to take into consideration.

If these risks are making you reconsider your opinion on Digital Domain Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.