Subdued Growth No Barrier To Constellation Software Inc.'s (TSE:CSU) Price

You may think that with a price-to-sales (or "P/S") ratio of 7.3x Constellation Software Inc. (TSE:CSU) is a stock to avoid completely, seeing as almost half of all the Software companies in Canada have P/S ratios under 3.6x and even P/S lower than 1.5x aren't out of the ordinary. 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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Check out our latest analysis for Constellation Software

How Has Constellation Software Performed Recently?

Recent revenue growth for Constellation Software has been in line with the industry. 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.

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

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Constellation Software would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an exceptional 17% gain to the company's top line. The latest three year period has also seen an excellent 93% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 19% per year as estimated by the ten analysts watching the company. That's shaping up to be materially lower than the 28% each year growth forecast for the broader industry.

With this in consideration, we believe it doesn't make sense that Constellation Software's P/S is outpacing its industry peers. 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. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Constellation Software's P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

It comes as a surprise to see Constellation Software trade at such a high P/S given the revenue forecasts look less than stellar. 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. At these price levels, investors should remain cautious, particularly if things don't improve.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Constellation Software that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.