The Cato Corporation (NYSE:CATO) shares have had a really impressive month, gaining 27% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 22% over that time.
Although its price has surged higher, you could still be forgiven for feeling indifferent about Cato's P/S ratio of 0.2x, since the median price-to-sales (or "P/S") ratio for the Specialty Retail industry in the United States is also close to 0.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.
How Has Cato Performed Recently?
For example, consider that Cato's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.
Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Cato will help you shine a light on its historical performance.
Do Revenue Forecasts Match The P/S Ratio?
There's an inherent assumption that a company should be matching the industry for P/S ratios like Cato's to be considered reasonable.
In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 7.0%. The last three years don't look nice either as the company has shrunk revenue by 6.6% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.
Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 3.8% shows it's an unpleasant look.
With this information, we find it concerning that Cato is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a 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 Final Word
Cato'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.
We find it unexpected that Cato trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected 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. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Before you settle on your opinion, we've discovered 2 warning signs for Cato that you should be aware of.
If you're unsure about the strength of Cato'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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