Pinning Down Palo Alto Networks, Inc.'s (NASDAQ:PANW) P/S Is Difficult Right Now

You may think that with a price-to-sales (or "P/S") ratio of 12.7x Palo Alto Networks, Inc. (NASDAQ:PANW) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.5x and even P/S lower than 1.8x aren't out of the ordinary. 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.

View our latest analysis for Palo Alto Networks

What Does Palo Alto Networks' Recent Performance Look Like?

Recent times have been advantageous for Palo Alto Networks as its revenues have been rising faster than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

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 Palo Alto Networks' to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 24%. The latest three year period has also seen an excellent 101% overall rise in revenue, aided by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 18% each year as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 17% each year, which is not materially different.

In light of this, it's curious that Palo Alto Networks' P/S sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Bottom Line On Palo Alto Networks' P/S

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 Palo Alto Networks' revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Palo Alto Networks, and understanding should be part of your investment process.

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.