Megaport Limited's (ASX:MP1) 26% Price Boost Is Out Of Tune With Revenues

Despite an already strong run, Megaport Limited (ASX:MP1) shares have been powering on, with a gain of 26% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 15% over that time.

After such a large jump in price, when almost half of the companies in Australia's IT industry have price-to-sales ratios (or "P/S") below 1.5x, you may consider Megaport as a stock not worth researching with its 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.

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View our latest analysis for Megaport

How Has Megaport Performed Recently?

With revenue growth that's superior to most other companies of late, Megaport has been doing relatively well. The P/S is probably high because investors think this strong revenue performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Do Revenue Forecasts Match The High P/S Ratio?

Megaport'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 17% last year. Pleasingly, revenue has also lifted 121% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 23% per annum, which is noticeably more attractive.

In light of this, it's alarming that Megaport's P/S sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

The Bottom Line On Megaport's P/S

Megaport's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

It comes as a surprise to see Megaport trade at such a high P/S given the revenue forecasts look less than stellar. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 1 warning sign for Megaport you should be aware of.

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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.