Diving Deep: Cautionary Tale of Zhihu Inc. (NYSE:ZH)

Zhihu Inc. has a price-to-sales (P/S) ratio of 1.4x, which is similar to the industry average. The company has been growing its revenue and is expected to continue doing so in the next three years. However, the market may not be convinced of its future growth potential. The P/S ratio is not reflecting the positive revenue outlook, which could present an attractive opportunity for investors. There are also other risk factors to consider before investing.
Jul. 16, 2023 08:51
Diving Deep: Cautionary Tale of Zhihu Inc. (NYSE:ZH)

There wouldn't be many who think Zhihu Inc.'s ( ) price-to-sales (or "P/S") ratio of 1.4x is worth a mention when the median P/S for the Interactive Media and Services industry in the United States is similar at about 1.6x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Zhihu certainly has been doing a good job lately as it's been growing revenue more than most other companies. One possibility is that the P/S ratio is moderate because investors think this strong revenue performance might be about to tail off. If the company manages to stay the course, then investors should be rewarded with a share price that matches its revenue figures.

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Zhihu'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 22% gain to the company's top line. This great performance means it was also able to deliver immense revenue growth over the last three years. Accordingly, shareholders would have been over the moon with those medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 23% each year as estimated by the twelve analysts watching the company. Meanwhile, the rest of the industry is forecast to only expand by 10% each year, which is noticeably less attractive.

With this information, we find it interesting that Zhihu is trading at a fairly similar P/S compared to the industry. It may be that most investors aren't convinced the company can achieve future growth expectations.

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Looking at Zhihu's analyst forecasts revealed that its superior revenue outlook isn't giving the boost to its P/S that we would've expected. There could be some risks that the market is pricing in, which is preventing the P/S ratio from matching the positive outlook. However, if you agree with the analysts' forecasts, you may be able to pick up the stock at an attractive price.

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What are the risks and opportunities for Zhihu ?

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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.