You may think that with a price-to-sales (or "P/S") ratio of 10.8x AppFolio, Inc. (NASDAQ:APPF) 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 1.7x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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. If not, then existing shareholders might be a little nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, AppFolio would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that the company grew revenue by an impressive 36% last year. The latest three year period has also seen an excellent 123% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next year should generate growth of 18% as estimated by the eight analysts watching the company. With the industry only predicted to deliver 14%, the company is positioned for a stronger revenue result.

In light of this, it's understandable that AppFolio's P/S sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

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.

We've established that AppFolio maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Software industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with AppFolio, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com