You may think that with a price-to-sales (or "P/S") ratio of 7.1x Smartsheet Inc. (NYSE:SMAR) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.6x and even P/S lower than 1.8x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Smartsheet

How Smartsheet Has Been Performing

Smartsheet certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Smartsheet's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Smartsheet's is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that the company grew revenue by an impressive 28% last year. The latest three year period has also seen an excellent 158% overall rise in revenue, aided by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 21% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 17% each year growth forecast for the broader industry.

With this information, we can see why Smartsheet is trading at such a high P/S compared to the industry. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Smartsheet's analyst forecasts revealed that its superior revenue outlook is contributing to its high P/S. It appears that shareholders are confident in the company's future revenues, which is propping up the P/S. Unless the analysts have really missed the mark, these strong revenue forecasts should keep the share price buoyant.

It is also worth noting that we have found 2 warning signs for Smartsheet that you need to take into consideration.

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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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.