DigitalOcean Holdings, Inc.'s (NYSE:DOCN) price-to-sales (or "P/S") ratio of 4.7x may look like a poor investment opportunity when you consider close to half the companies in the IT industry in the United States have P/S ratios below 2.6x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has DigitalOcean Holdings Performed Recently?

Recent times have been advantageous for DigitalOcean Holdings as its revenues have been rising faster than most other companies. 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?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 12% last year. The latest three year period has also seen an excellent 91% 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.

Shifting to the future, estimates from the twelve analysts covering the company suggest revenue should grow by 15% each year over the next three years. That's shaping up to be materially higher than the 13% per annum growth forecast for the broader industry.

In light of this, it's understandable that DigitalOcean Holdings' P/S sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On DigitalOcean Holdings' P/S

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.

As we suspected, our examination of DigitalOcean Holdings' 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. 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 4 warning signs for DigitalOcean Holdings (2 don't sit too well with us!) that you need to take into consideration.

If these risks are making you reconsider your opinion on DigitalOcean Holdings, 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.