When you see that almost half of the companies in the IT industry in the United States have price-to-sales ratios (or "P/S") below 2x, Cloudflare, Inc. (NYSE:NET) looks to be giving off strong sell signals with its 18.4x P/S ratio. 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.

What Does Cloudflare's P/S Mean For Shareholders?

Recent times have been advantageous for Cloudflare as its revenues have been rising faster than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Cloudflare?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Cloudflare's to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 31%. The strong recent performance means it was also able to grow revenue by 179% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 29% per year as estimated by the analysts watching the company. With the industry only predicted to deliver 11% per annum, the company is positioned for a stronger revenue result.

With this in mind, it's not hard to understand why Cloudflare's P/S is high relative to its industry peers. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What Does Cloudflare's P/S Mean For Investors?

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Cloudflare maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the IT 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Cloudflare you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

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