Novanta Inc.'s (NASDAQ:NOVT) price-to-sales (or "P/S") ratio of 6.5x may look like a poor investment opportunity when you consider close to half the companies in the Electronic industry in the United States have P/S ratios below 2.1x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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

Novanta certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Novanta's Revenue Growth Trending?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 3.9% last year. Pleasingly, revenue has also lifted 41% 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.

Looking ahead now, revenue is anticipated to climb by 10% during the coming year according to the four analysts following the company. With the industry predicted to deliver 9.1% growth , the company is positioned for a comparable revenue result.

In light of this, it's curious that Novanta'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 Novanta's P/S

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Given Novanta's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

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

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

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