With a price-to-sales (or "P/S") ratio of 2.8x SolarWinds Corporation (NYSE:SWI) may be sending bullish signals at the moment, given that almost half of all the Software companies in the United States have P/S ratios greater than 4.5x and even P/S higher than 11x are not unusual. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

How Has SolarWinds Performed Recently?

With revenue growth that's inferior to most other companies of late, SolarWinds has been relatively sluggish. Perhaps the market is expecting the current trend of poor revenue growth to continue, which has kept the P/S suppressed. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

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

In order to justify its P/S ratio, SolarWinds would need to produce sluggish growth that's trailing the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 5.0%. The latest three year period has also seen a 7.4% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 3.4% during the coming year according to the seven analysts following the company. With the industry predicted to deliver 20% growth, the company is positioned for a weaker revenue result.

With this information, we can see why SolarWinds is trading at a P/S lower than the industry. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that SolarWinds maintains its low P/S on the weakness of its forecast growth being lower than the wider industry, as expected. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 3 warning signs for SolarWinds you should be aware of, and 1 of them can't be ignored.

If these risks are making you reconsider your opinion on SolarWinds, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.