You may think that with a price-to-sales (or "P/S") ratio of 0.8x Compass Diversified (NYSE:CODI) is a stock worth checking out, seeing as almost half of all the Diversified Financial companies in the United States have P/S ratios greater than 2.7x and even P/S higher than 5x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

How Has Compass Diversified Performed Recently?

With revenue growth that's inferior to most other companies of late, Compass Diversified has been relatively sluggish. Perhaps the market is expecting the current trend of poor revenue growth to continue, which has kept the P/S suppressed. If you still like the company, you'd be hoping revenue doesn't get any worse and that you could pick up some stock while it's out of favour.

Do Revenue Forecasts Match The Low P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as low as Compass Diversified's is when the company's growth is on track to lag the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 10%. Pleasingly, revenue has also lifted 33% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next year should generate growth of 8.3% as estimated by the seven analysts watching the company. With the industry only predicted to deliver 4.5%, the company is positioned for a stronger revenue result.

With this in consideration, we find it intriguing that Compass Diversified's P/S sits behind most of its industry peers. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Bottom Line On Compass Diversified's P/S

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.

To us, it seems Compass Diversified currently trades on a significantly depressed P/S given its forecasted revenue growth is higher than the rest of its industry. There could be some major risk factors that are placing downward pressure on the P/S ratio. At least price risks look to be very low, but investors seem to think future revenues could see a lot of volatility.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Compass Diversified (2 don't sit too well with us) you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.