There wouldn't be many who think Rapid7, Inc.'s (NASDAQ:RPD) price-to-sales (or "P/S") ratio of 4.2x is worth a mention when the median P/S for the Software industry in the United States is similar at about 4.4x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

See our latest analysis for Rapid7

How Rapid7 Has Been Performing

Recent times have been advantageous for Rapid7 as its revenues have been rising faster than most other companies. One possibility is that the P/S ratio is moderate because investors think this strong revenue performance might be about to tail off. If the company manages to stay the course, then investors should be rewarded with a share price that matches its revenue figures.

Is There Some Revenue Growth Forecasted For Rapid7?

The only time you'd be comfortable seeing a P/S like Rapid7's is when the company's growth is tracking the industry closely.

Taking a look back first, we see that the company grew revenue by an impressive 16% last year. The latest three year period has also seen an excellent 94% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Looking ahead now, revenue is anticipated to climb by 15% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 17% each year growth forecast for the broader industry.

With this information, we find it interesting that Rapid7 is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

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.

When you consider that Rapid7's revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. At present, we aren't confident in the P/S as the predicted future revenues aren't likely to support a more positive sentiment for long. Circumstances like this present a risk to current and prospective investors who may see share prices fall if the low revenue growth impacts the sentiment.

You need to take note of risks, for example - Rapid7 has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

If you're unsure about the strength of Rapid7'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.