When close to half the companies in the Aerospace & Defense industry in the United States have price-to-sales ratios (or "P/S") below 2.3x, you may consider AeroVironment, Inc. (NASDAQ:AVAV) as a stock to avoid entirely with its 6.6x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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

Recent times have been advantageous for AeroVironment as its revenues have been rising faster 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 AeroVironment's Revenue Growth Trending?

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

Taking a look back first, we see that the company grew revenue by an impressive 33% last year. Pleasingly, revenue has also lifted 81% in aggregate from three years ago, 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 16% each year during the coming three years according to the five analysts following the company. Meanwhile, the rest of the industry is forecast to only expand by 2.5% each year, which is noticeably less attractive.

With this information, we can see why AeroVironment 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

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that AeroVironment maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Aerospace & Defense industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. Unless the analysts have really missed the mark, these strong revenue forecasts should keep the share price buoyant.

Plus, you should also learn about this 1 warning sign we've spotted with AeroVironment.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

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