Subdued Growth No Barrier To Megaport Limited (ASX:MP1) With Shares Advancing 27%

Megaport Limited (ASX:MP1) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 31% in the last twelve months.

After such a large jump in price, you could be forgiven for thinking Megaport is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.3x, considering almost half the companies in Australia's IT industry have P/S ratios below 2.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Megaport

What Does Megaport's Recent Performance Look Like?

Megaport certainly has been doing a good job lately as it's been growing revenue more than most other companies. 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.

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

How Is Megaport's Revenue Growth Trending?

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

Taking a look back first, we see that the company grew revenue by an impressive 28% last year. The latest three year period has also seen an excellent 149% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Looking ahead now, revenue is anticipated to climb by 13% each year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 20% per year growth forecast for the broader industry.

With this in consideration, we believe it doesn't make sense that Megaport's P/S is outpacing its industry peers. 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

The strong share price surge has lead to Megaport's P/S soaring as well. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Megaport with six simple checks on some of these key factors.

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.