You may think that with a price-to-sales (or "P/S") ratio of 8.5x JFrog Ltd. (NASDAQ:FROG) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 5.6x and even P/S lower than 2x 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 JFrog's P/S Mean For Shareholders?

JFrog certainly has been doing a good job lately as it's been growing revenue more 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.

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

JFrog's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that the company grew revenue by an impressive 24% last year. The strong recent performance means it was also able to grow revenue by 115% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 18% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 21% per year, which is noticeably more attractive.

With this information, we find it concerning that JFrog is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What Does JFrog's P/S Mean For Investors?

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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for JFrog, this doesn't appear to be impacting the P/S in the slightest. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider and we've discovered 4 warning signs for JFrog (1 is potentially serious!) that you should be aware of before investing here.

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.