With a price-to-sales (or "P/S") ratio of 8.2x Workday, Inc. (NASDAQ:WDAY) 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 1.8x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Workday Performed Recently?

There hasn't been much to differentiate Workday's and the industry's revenue growth lately. One possibility is that the P/S ratio is high because investors think this modest revenue performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Workday?

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

Taking a look back first, we see that the company grew revenue by an impressive 17% last year. The latest three year period has also seen an excellent 68% overall rise in revenue, aided by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 14% each year over the next three years. With the industry predicted to deliver 20% growth each year, the company is positioned for a weaker revenue result.

With this in consideration, we believe it doesn't make sense that Workday's P/S is outpacing its industry peers. 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.

What Does Workday'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.

We've concluded that Workday 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. At these price levels, investors should remain cautious, particularly if things don't improve.

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 Workday with six simple checks.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.