When close to half the companies in the Electronic industry in the United States have price-to-sales ratios (or "P/S") below 2x, you may consider Novanta Inc. (NASDAQ:NOVT) as a stock to avoid entirely with its 7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Novanta's Recent Performance Look Like?

With its revenue growth in positive territory compared to the declining revenue of most other companies, Novanta has been doing quite well of late. Perhaps the market is expecting the company's future revenue growth to buck the trend of the industry, contributing to a higher P/S. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Novanta's Revenue Growth Trending?

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

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. Still, the latest three year period has seen an excellent 49% overall rise in revenue, in spite of its uninspiring short-term performance. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

Turning to the outlook, the next year should generate growth of 12% as estimated by the three analysts watching the company. With the industry only predicted to deliver 7.2%, the company is positioned for a stronger revenue result.

With this in mind, it's not hard to understand why Novanta's P/S is high relative to its industry peers. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Novanta's P/S

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our look into Novanta shows that its P/S ratio remains high on the merit of its strong future revenues. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

It is also worth noting that we have found 1 warning sign for Novanta 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.

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