Some Shareholders Feeling Restless Over JFrog Ltd.'s (NASDAQ:FROG) P/S Ratio

You may think that with a price-to-sales (or "P/S") ratio of 8.8x JFrog Ltd. (NASDAQ:FROG) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.8x and even P/S lower than 1.9x 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.

See our latest analysis for JFrog

How JFrog Has Been Performing

With revenue growth that's superior to most other companies of late, JFrog has been doing relatively well. The P/S is probably high because investors think this strong revenue performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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 JFrog's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 25% last year. Pleasingly, revenue has also lifted 122% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next three years should generate growth of 19% per year as estimated by the analysts watching the company. That's shaping up to be similar to the 20% per annum growth forecast for the broader industry.

With this information, we find it interesting that JFrog is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

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.

Given JFrog's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. 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.

There are also other vital risk factors to consider and we've discovered 4 warning signs for JFrog (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If you're unsure about the strength of JFrog'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.