Sprout Social, Inc.'s (NASDAQ:SPT) price-to-sales (or "P/S") ratio of 10.8x might make it look like a strong sell right now compared to the Software industry in the United States, where around half of the companies have P/S ratios below 4.4x and even P/S below 1.8x are quite common. 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.

Check out our latest analysis for Sprout Social

What Does Sprout Social's P/S Mean For Shareholders?

Sprout Social certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Sprout Social's is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that the company grew revenue by an impressive 30% last year. Pleasingly, revenue has also lifted 150% 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 30% during the coming year according to the twelve analysts following the company. Meanwhile, the rest of the industry is forecast to only expand by 15%, which is noticeably less attractive.

With this information, we can see why Sprout Social is trading at such a high P/S compared to the industry. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

We've established that Sprout Social 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. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You need to take note of risks, for example - Sprout Social has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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.