Pinning Down Confluent, Inc.'s (NASDAQ:CFLT) P/S Is Difficult Right Now

Confluent, Inc.'s (NASDAQ:CFLT) price-to-sales (or "P/S") ratio of 8.6x might make it look like a strong sell right now compared to 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 2x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

Check out our latest analysis for Confluent

What Does Confluent's Recent Performance Look Like?

Confluent certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Confluent.

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

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

Retrospectively, the last year delivered an exceptional 24% gain to the company's top line. Pleasingly, revenue has also lifted 133% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 18% each year over the next three years. That's shaping up to be similar to the 16% per year growth forecast for the broader industry.

With this information, we find it interesting that Confluent is trading at a high P/S compared to the industry. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Analysts are forecasting Confluent's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 2 warning signs for Confluent 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.