Spotify Technology S.A.'s (NYSE:SPOT) price-to-sales (or "P/S") ratio of 4.6x may look like a poor investment opportunity when you consider close to half the companies in the Entertainment industry in the United States have P/S ratios below 1.4x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Spotify Technology Has Been Performing

Recent times haven't been great for Spotify Technology as its revenue has been rising slower than most other companies. Perhaps the market is expecting future revenue performance to undergo a reversal of fortunes, which has elevated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Spotify Technology's Revenue Growth Trending?

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

Retrospectively, the last year delivered an exceptional 17% gain to the company's top line. The latest three year period has also seen an excellent 68% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 14% per annum over the next three years. Meanwhile, the rest of the industry is forecast to only expand by 10% each year, which is noticeably less attractive.

With this information, we can see why Spotify Technology is trading at such a high P/S compared to the industry. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

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.

As we suspected, our examination of Spotify Technology's analyst forecasts revealed that its superior revenue outlook is contributing to its high P/S. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. Unless these conditions change, they will continue to provide strong support to the share price.

You always need to take note of risks, for example - Spotify Technology has 2 warning signs we think you should be aware of.

If you're unsure about the strength of Spotify Technology's 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.