Nature Wood Group Limited (NASDAQ:NWGL) shares have had a horrible month, losing 75% after a relatively good period beforehand. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

Although its price has dipped substantially, given around half the companies in the United States' Forestry industry have price-to-sales ratios (or "P/S") below 0.4x, you may still consider Nature Wood Group as a stock to avoid entirely with its 2.4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Nature Wood Group Performed Recently?

As an illustration, revenue has deteriorated at Nature Wood Group over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Nature Wood Group's earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Nature Wood Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 54% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 32% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 5.4% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Nature Wood Group's P/S exceeds that of its industry peers. 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

Nature Wood Group's shares may have suffered, but its P/S remains high. 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 established that Nature Wood Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Nature Wood Group (2 are concerning) you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.