You may think that with a price-to-sales (or "P/S") ratio of 12.4x GitLab Inc. (NASDAQ:GTLB) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.3x and even P/S lower than 1.5x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How GitLab Has Been Performing

GitLab 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

GitLab's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that the company grew revenue by an impressive 34% last year. Pleasingly, revenue has also lifted 266% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Looking ahead now, revenue is anticipated to climb by 24% each year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 15% per year growth forecast for the broader industry.

With this in mind, it's not hard to understand why GitLab's P/S is high relative to its industry peers. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

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.

We've established that GitLab maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Software industry, as expected. Right now shareholders are comfortable with the P/S as they are quite confident future revenues aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Having said that, be aware GitLab is showing 2 warning signs in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on GitLab, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com