ArcSoft Corporation Limited's (SHSE:688088) price-to-sales (or "P/S") ratio of 26.3x may look like a poor investment opportunity when you consider close to half the companies in the Software industry in China have P/S ratios below 6.6x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

See our latest analysis for ArcSoft

How Has ArcSoft Performed Recently?

ArcSoft certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

In order to justify its P/S ratio, ArcSoft would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 24%. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 1.3% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Shifting to the future, estimates from the three analysts covering the company suggest revenue should grow by 37% over the next year. That's shaping up to be similar to the 37% growth forecast for the broader industry.

In light of this, it's curious that ArcSoft's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Bottom Line On ArcSoft's P/S

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.

Analysts are forecasting ArcSoft's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you take the next step, you should know about the 1 warning sign for ArcSoft that we have uncovered.

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.