What Constellation Software Inc.'s (TSE:CSU) P/S Is Not Telling You

With a price-to-sales (or "P/S") ratio of 6.5x Constellation Software Inc. (TSE:CSU) may be sending very bearish signals at the moment, given that almost half of all the Software companies in Canada have P/S ratios under 3.8x and even P/S lower than 1.5x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Constellation Software

What Does Constellation Software's Recent Performance Look Like?

With revenue growth that's superior to most other companies of late, Constellation Software has been doing relatively well. The P/S is probably high because investors think this strong revenue performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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.

Is There Enough Revenue Growth Forecasted For Constellation Software?

Constellation Software'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 grew revenue by an impressive 29% last year. The strong recent performance means it was also able to grow revenue by 107% in total over the last three years. So we can start by confirming that the company has done a great job of growing revenue over that time.

Shifting to the future, estimates from the eight analysts covering the company suggest revenue should grow by 19% over the next year. Meanwhile, the rest of the industry is forecast to expand by 19%, which is not materially different.

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. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

What We Can Learn From Constellation Software's P/S?

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

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. Unless the company can jump ahead of the rest of the industry in the short-term, it'll be a challenge to maintain the share price at current levels.

It is also worth noting that we have found 2 warning signs for Constellation Software that you need to take into consideration.

If you're unsure about the strength of Constellation Software's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.