With a price-to-sales (or "P/S") ratio of 6.6x Q2 Holdings, Inc. (NYSE:QTWO) may be sending bearish signals at the moment, given that almost half of all Software companies in the United States have P/S ratios under 4.5x and even P/S lower than 1.7x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Q2 Holdings' P/S Mean For Shareholders?

Recent times haven't been great for Q2 Holdings as its revenue has been rising slower than most other companies. 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?

The only time you'd be truly comfortable seeing a P/S as high as Q2 Holdings' is when the company's growth is on track to outshine the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 9.5% last year. The latest three year period has also seen an excellent 45% overall rise in revenue, aided somewhat by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next year should generate growth of 12% as estimated by the analysts watching the company. That's shaping up to be materially lower than the 21% growth forecast for the broader industry.

With this information, we find it concerning that Q2 Holdings 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

It comes as a surprise to see Q2 Holdings trade at such a high P/S given the revenue forecasts look less than stellar. 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Q2 Holdings 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.