What NEXTDC Limited's (ASX:NXT) 25% Share Price Gain Is Not Telling You

NEXTDC Limited (ASX:NXT) shareholders have had their patience rewarded with a 25% share price jump in the last month. Notwithstanding the latest gain, the annual share price return of 6.0% isn't as impressive.

Following the firm bounce in price, when almost half of the companies in Australia's IT industry have price-to-sales ratios (or "P/S") below 1.7x, you may consider NEXTDC as a stock not worth researching with its 26.7x 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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View our latest analysis for NEXTDC

How Has NEXTDC Performed Recently?

There hasn't been much to differentiate NEXTDC's and the industry's revenue growth lately. One possibility is that the P/S ratio is high because investors think this modest revenue performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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.

How Is NEXTDC's Revenue Growth Trending?

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.

Taking a look back first, we see that the company managed to grow revenues by a handy 5.7% last year. Pleasingly, revenue has also lifted 47% in aggregate from three years ago, partly thanks to the last 12 months of growth. 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 26% each year during the coming three years according to the analysts following the company. That's shaping up to be similar to the 29% per year growth forecast for the broader industry.

With this in consideration, we find it intriguing that NEXTDC's P/S is higher than its industry peers. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Final Word

The strong share price surge has lead to NEXTDC's P/S soaring as well. 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.

Given NEXTDC's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

You should always think about risks. Case in point, we've spotted 3 warning signs for NEXTDC you should be aware of, and 2 of them make us uncomfortable.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.