With a price-to-sales (or "P/S") ratio of 24.7x Fair Isaac Corporation (NYSE:FICO) may be sending very bearish signals at the moment, given that almost half of all the Software companies in the United States have P/S ratios under 4.8x and even P/S lower than 1.7x are not unusual. 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.

How Has Fair Isaac Performed Recently?

With revenue growth that's inferior to most other companies of late, Fair Isaac has been relatively sluggish. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a decent 13% gain to the company's revenues. The solid recent performance means it was also able to grow revenue by 20% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Looking ahead now, revenue is anticipated to climb by 13% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 15% per annum, which is not materially different.

With this information, we find it interesting that Fair Isaac is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Fair Isaac's P/S Mean For Investors?

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 Fair Isaac's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 2 warning signs for Fair Isaac you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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