Technology One Limited's (ASX:TNE) 31% Price Boost Is Out Of Tune With Revenues

Technology One Limited (ASX:TNE) shares have had a really impressive month, gaining 31% after a shaky period beforehand. The annual gain comes to 119% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, given around half the companies in Australia's Software industry have price-to-sales ratios (or "P/S") below 3.2x, you may consider Technology One as a stock to avoid entirely with its 21.8x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

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See our latest analysis for Technology One

How Has Technology One Performed Recently?

Technology One's revenue growth of late has been pretty similar to most other companies. Perhaps the market is expecting future revenue performance to improve, justifying the currently elevated P/S. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Technology One.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Technology One 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 18% last year. Pleasingly, revenue has also lifted 63% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 15% per year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 45% per annum, which is noticeably more attractive.

In light of this, it's alarming that Technology One's P/S sits above the majority of other companies. 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. 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.

What We Can Learn From Technology One's P/S?

The strong share price surge has lead to Technology One'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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Technology One, this doesn't appear to be impacting the P/S in the slightest. 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 Technology One with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on Technology One, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.