When close to half the companies in the Communications industry in the United States have price-to-sales ratios (or "P/S") below 1.3x, you may consider Viavi Solutions Inc. (NASDAQ:VIAV) as a stock to potentially avoid with its 2.2x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Viavi Solutions

How Has Viavi Solutions Performed Recently?

While the industry has experienced revenue growth lately, Viavi Solutions' revenue has gone into reverse gear, which is not great. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Viavi Solutions?

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

Retrospectively, the last year delivered a frustrating 18% decrease to the company's top line. As a result, revenue from three years ago have also fallen 6.9% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Turning to the outlook, the next year should bring diminished returns, with revenue decreasing 0.8% as estimated by the eight analysts watching the company. That's not great when the rest of the industry is expected to grow by 0.5%.

With this in mind, we find it intriguing that Viavi Solutions' P/S is closely matching its industry peers. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the negative growth outlook.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Viavi Solutions currently trades on a much higher than expected P/S for a company whose revenues are forecast to decline. Right now we aren't comfortable with the high P/S as the predicted future revenue decline likely to impact the positive sentiment that's propping up the P/S. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Viavi Solutions you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.