When close to half the companies in the Interactive Media and Services industry in the United States have price-to-sales ratios (or "P/S") below 1.4x, you may consider CarGurus, Inc. (NASDAQ:CARG) as a stock to potentially avoid with its 3x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How CarGurus Has Been Performing

CarGurus could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. 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?

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

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 38%. However, a few very strong years before that means that it was still able to grow revenue by an impressive 59% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 9.1% per annum as estimated by the analysts watching the company. With the industry predicted to deliver 12% growth per year, the company is positioned for a weaker revenue result.

In light of this, it's alarming that CarGurus' P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

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 concluded that CarGurus currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. At these price levels, investors should remain cautious, particularly if things don't improve.

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

If you're unsure about the strength of CarGurus' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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