Why Investors Shouldn't Be Surprised By Spotify Technology S.A.'s (NYSE:SPOT) P/S

When you see that almost half of the companies in the Entertainment industry in the United States have price-to-sales ratios (or "P/S") below 1.4x, Spotify Technology S.A. (NYSE:SPOT) looks to be giving off strong sell signals with its 5.5x P/S ratio. 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 Spotify Technology

How Has Spotify Technology Performed Recently?

Recent times haven't been great for Spotify Technology as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

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

How Is Spotify Technology's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Spotify Technology's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 17% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 68% in total over the last three years. 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 15% each year as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to only expand by 11% per annum, which is noticeably less attractive.

In light of this, it's understandable that Spotify Technology's P/S sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

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.

Our look into Spotify Technology shows that its P/S ratio remains high on the merit of its strong future revenues. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. Unless the analysts have really missed the mark, these strong revenue forecasts should keep the share price buoyant.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Spotify Technology 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.