Constellation Software Inc.'s (TSE:CSU) Shares May Have Run Too Fast Too Soon

Constellation Software Inc.'s (TSE:CSU) price-to-sales (or "P/S") ratio of 6.6x may look like a poor investment opportunity when you consider close to half the companies in the Software industry in Canada have P/S ratios below 3.1x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Constellation Software

What Does Constellation Software's Recent Performance Look Like?

Constellation Software could be doing better as it's been growing revenue less than most other companies lately. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

How Is Constellation Software's Revenue Growth Trending?

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

If we review the last year of revenue growth, the company posted a terrific increase of 27%. Pleasingly, revenue has also lifted 112% in aggregate from three years ago, 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 20% during the coming year according to the seven analysts following the company. With the industry predicted to deliver 20% growth , the company is positioned for a comparable revenue result.

With this in consideration, we find it intriguing that Constellation Software'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. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Constellation Software's P/S Mean For Investors?

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.

Analysts are forecasting Constellation Software's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Constellation Software that you should be aware of.

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.