NEXTDC Limited's (ASX:NXT) Share Price Not Quite Adding Up

When close to half the companies in the IT industry in Australia have price-to-sales ratios (or "P/S") below 1.4x, you may consider NEXTDC Limited (ASX:NXT) as a stock to avoid entirely with its 16.1x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

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See our latest analysis for NEXTDC

What Does NEXTDC's Recent Performance Look Like?

NEXTDC hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Keen to find out how analysts think NEXTDC's future stacks up against the industry? In that case, our free report is a great place to start .

Is There Enough Revenue Growth Forecasted For NEXTDC?

NEXTDC'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.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 2.7%. Even so, admirably revenue has lifted 49% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 20% per year during the coming three years according to the analysts following the company. With the industry predicted to deliver 24% growth each year, the company is positioned for a weaker revenue result.

With this information, we find it concerning that NEXTDC is trading at a P/S higher than the industry. 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. 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.

The Bottom Line On NEXTDC's P/S

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.

We've concluded that NEXTDC currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with NEXTDC (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

If you're unsure about the strength of NEXTDC's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.