Potential Upside For Xref Limited (ASX:XF1) Not Without Risk

You may think that with a price-to-sales (or "P/S") ratio of 1.3x Xref Limited (ASX:XF1) is a stock worth checking out, seeing as almost half of all the Software companies in Australia have P/S ratios greater than 2.5x and even P/S higher than 6x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

See our latest analysis for Xref

What Does Xref's Recent Performance Look Like?

Xref has been doing a good job lately as it's been growing revenue at a solid pace. One possibility is that the P/S is low because investors think this respectable revenue growth might actually underperform the broader industry in the near future. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Xref's earnings, revenue and cash flow.

How Is Xref's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as low as Xref's is when the company's growth is on track to lag the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 9.7% last year. This was backed up an excellent period prior to see revenue up by 154% in total over the last three years. So we can start by confirming that the company has done a great job of growing revenues over that time.

Comparing that recent medium-term revenue trajectory with the industry's one-year growth forecast of 23% shows it's noticeably more attractive.

In light of this, it's peculiar that Xref's P/S sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Bottom Line On Xref's P/S

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We're very surprised to see Xref currently trading on a much lower than expected P/S since its recent three-year growth is higher than the wider industry forecast. When we see strong revenue with faster-than-industry growth, we assume there are some significant underlying risks to the company's ability to make money which is applying downwards pressure on the P/S ratio. At least price risks look to be very low if recent medium-term revenue trends continue, but investors seem to think future revenue could see a lot of volatility.

Having said that, be aware Xref is showing 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.