PagerDuty, Inc.'s (NYSE:PD) price-to-sales (or "P/S") ratio of 4x might make it look like a buy right now compared to the Software industry in the United States, where around half of the companies have P/S ratios above 5.8x and even P/S above 13x are quite common. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does PagerDuty's Recent Performance Look Like?

Recent times haven't been great for PagerDuty as its revenue has been rising slower than most other companies. The P/S ratio is probably low because investors think this lacklustre revenue performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

How Is PagerDuty's Revenue Growth Trending?

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

Retrospectively, the last year delivered a decent 8.7% gain to the company's revenues. The latest three year period has also seen an excellent 74% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next year should generate growth of 9.3% as estimated by the twelve analysts watching the company. That's shaping up to be materially lower than the 26% growth forecast for the broader industry.

With this in consideration, its clear as to why PagerDuty's P/S is falling short industry peers. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

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.

As expected, our analysis of PagerDuty's analyst forecasts confirms that the company's underwhelming revenue outlook is a major contributor to its low P/S. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for PagerDuty you should be aware of.

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.