Cadence Design Systems, Inc. (NASDAQ:CDNS) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Looking further back, the 15% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, Cadence Design Systems' price-to-sales (or "P/S") ratio of 19.6x might make it look like a strong sell right now compared to other companies in the Software industry in the United States, where around half of the companies have P/S ratios below 5.3x and even P/S below 1.9x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Cadence Design Systems Has Been Performing

With revenue growth that's inferior to most other companies of late, Cadence Design Systems has been relatively sluggish. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

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 Cadence Design Systems' to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 11%. The latest three year period has also seen an excellent 46% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.

Looking ahead now, revenue is anticipated to climb by 14% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 21% each year, which is noticeably more attractive.

With this information, we find it concerning that Cadence Design Systems is trading at a P/S higher than the industry. 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. 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 Cadence Design Systems' P/S?

Shares in Cadence Design Systems have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 concluded that Cadence Design Systems currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Cadence Design Systems with six simple checks.

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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