You may think that with a price-to-sales (or "P/S") ratio of 11.6x Aspen Technology, Inc. (NASDAQ:AZPN) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.2x and even P/S lower than 1.6x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.
What Does Aspen Technology's P/S Mean For Shareholders?
With revenue growth that's inferior to most other companies of late, Aspen Technology has been relatively sluggish. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
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What Are Revenue Growth Metrics Telling Us About The High P/S?
There's an inherent assumption that a company should far outperform the industry for P/S ratios like Aspen Technology's to be considered reasonable.
Retrospectively, the last year delivered a decent 8.0% gain to the company's revenues. This was backed up an excellent period prior to see revenue up by 275% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.
Looking ahead now, revenue is anticipated to climb by 7.2% per annum during the coming three years according to the eleven analysts following the company. With the industry predicted to deliver 18% growth each year, the company is positioned for a weaker revenue result.
With this information, we find it concerning that Aspen Technology is trading at a P/S higher than the industry. 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.
What We Can Learn From Aspen Technology's P/S?
It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've concluded that Aspen Technology 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Aspen Technology with six simple checks.
If these risks are making you reconsider your opinion on Aspen Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.
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