With a price-to-sales (or "P/S") ratio of 10.8x AppFolio, Inc. (NASDAQ:APPF) 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 5x and even P/S lower than 1.9x 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.

What Does AppFolio's P/S Mean For Shareholders?

With revenue growth that's superior to most other companies of late, AppFolio has been doing relatively well. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Retrospectively, the last year delivered an exceptional 33% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 127% in total over the last three years. 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 seven analysts covering the company suggest revenue should grow by 17% over the next year. That's shaping up to be materially lower than the 26% growth forecast for the broader industry.

With this information, we find it concerning that AppFolio is trading at a P/S higher than the industry. 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. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

What We Can Learn From AppFolio's P/S?

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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for AppFolio, this doesn't appear to be impacting the P/S in the slightest. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for AppFolio that you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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