2021 was not kind to the shares of ITM Power (LSE:ITM). And so far, 2022 hasn’t been much of an improvement. Over the last 12 months, the penny stock has tumbled by nearly 50%. What’s going on? And why am I steering clear of this business? Let’s explore.
Encouraging progress versus disappointing returns
As a quick reminder, ITM Power is a designer and manufacturer of electrolyser machines. These pieces of equipment can extract hydrogen from water without creating emissions. It’s a significantly greener approach to acquiring the element versus the traditional route of using fossil fuels.
Given the demand for hydrogen is expected to grow 10 times by 2050, the company certainly sounds like an excellent place to invest for explosive long-term gains. And it may not even take that long for bets to play out. While revenue for 2021 came in at a relatively tiny £4.3m, analyst forecasts for 2022 and 2023 are £22.8m and £65m, respectively.
Looking at the group’s contracted backlog, these estimates certainly sound plausible to me. And this explosive growth potential is primarily what pushed ITM Power shares to a new all-time high of 724p in January last year. But today, the stock is trading around 349p. So, what happened?
Taking a closer look at the numbers
As encouraging as the order backlog seems, I have some reservations. Firstly, a growing backlog is only a positive sign that the company can fulfil the orders. Let’s assume that’s the case with ITM Power. Looking at the latest figures published in December, the company has £591m worth of orders. However, £557m of that isn’t set in stone as these contracts are still being negotiated with only £198m in late stages talks.
That’s certainly nothing to scoff at. But it seems some investors may have been getting ahead of themselves. At its peak, shares of ITM Power had a market capitalisation of around £4.4bn. Today it’s closer to £2.2bn, but that still places the current price-to-sales (P/S) ratio at 511 times!
Assuming the 2023 revenue forecast is accurate, the forward P/S ratio comes in at a more reasonable 33 times. And to me, that suggests investors are pricing ITM Power shares on expectations rather than fundamentals.
So, what happens if the company fails to live up to these expectations? Well, we already know because that’s what happened in 2021. Full-year revenue missed analyst forecasts by a tiny £700k, but it still sent its share price plummeting.
Final thoughts on ITM Power shares
Seeing this level of volatility in a company with an exceptionally lofty valuation is hardly surprising. And I wouldn’t be surprised to see shares of ITM Power continue to fall if further targets are missed even by a relatively insignificant amount.
Personally, that’s not the sort of risk I’m interested in adding to my portfolio. Yes, there is a lot of growth potential here. But I believe other, less risky, investment opportunities could be far more lucrative.
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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.