There's Reason For Concern Over Cadence Design Systems, Inc.'s (NASDAQ:CDNS) Massive 25% Price Jump

Cadence Design Systems, Inc. (NASDAQ:CDNS) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Looking further back, the 15% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, Cadence Design Systems' price-to-sales (or "P/S") ratio of 19.6x might make it look like a strong sell right now compared to other companies in the Software industry in the United States, where around half of the companies have P/S ratios below 5.3x and even P/S below 1.9x are quite common. 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 Cadence Design Systems

What Does Cadence Design Systems' P/S Mean For Shareholders?

Recent times haven't been great for Cadence Design Systems 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.

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

Is There Enough Revenue Growth Forecasted For Cadence Design Systems?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 11% last year. The latest three year period has also seen an excellent 46% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 14% per annum over the next three years. That's shaping up to be materially lower than the 21% each year growth forecast for the broader industry.

In light of this, it's alarming that Cadence Design Systems' P/S sits above the majority of other companies. 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 Cadence Design Systems' P/S

Cadence Design Systems' P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

It comes as a surprise to see Cadence Design Systems trade at such a high P/S given the revenue forecasts look less than stellar. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Cadence Design Systems with six simple checks.

If these risks are making you reconsider your opinion on Cadence Design Systems, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.