Pinning Down REA Group Limited's (ASX:REA) P/S Is Difficult Right Now

When close to half the companies in the Interactive Media and Services industry in Australia have price-to-sales ratios (or "P/S") below 2.5x, you may consider REA Group Limited (ASX:REA) as a stock to avoid entirely with its 15.9x 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.

See our latest analysis for REA Group

What Does REA Group's P/S Mean For Shareholders?

There hasn't been much to differentiate REA Group's and the industry's revenue growth lately. It might be that many expect the mediocre revenue performance to strengthen positively, which has kept the P/S ratio from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

Want the full picture on analyst estimates for the company? Then our free report on REA Group will help you uncover what's on the horizon.

Is There Enough Revenue Growth Forecasted For REA Group?

In order to justify its P/S ratio, REA Group 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 20% last year. The latest three year period has also seen an excellent 67% 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 three years should generate growth of 4.2% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 8.8% each year, which is noticeably more attractive.

With this information, we find it concerning that REA Group 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. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

What We Can Learn From REA Group's P/S?

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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for REA Group, this doesn't appear to be impacting the P/S in the slightest. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. At these price levels, investors should remain cautious, particularly if things don't improve.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for REA Group with six simple checks.

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.