Some Confidence Is Lacking In Rapid7, Inc.'s (NASDAQ:RPD) P/S

It's not a stretch to say that Rapid7, Inc.'s (NASDAQ:RPD) price-to-sales (or "P/S") ratio of 4.8x right now seems quite "middle-of-the-road" for companies in the Software industry in the United States, where the median P/S ratio is around 4.7x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

View our latest analysis for Rapid7

What Does Rapid7's Recent Performance Look Like?

Rapid7 certainly has been doing a good job lately as it's been growing revenue more than most other companies. One possibility is that the P/S ratio is moderate because investors think this strong revenue performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Rapid7.

Do Revenue Forecasts Match The P/S Ratio?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Rapid7's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 16% last year. The latest three year period has also seen an excellent 94% overall rise in revenue, aided by its short-term performance. 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 15% each year as estimated by the analysts watching the company. With the industry predicted to deliver 17% growth per year, the company is positioned for a weaker revenue result.

With this information, we find it interesting that Rapid7 is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of revenue growth is likely to weigh down the shares eventually.

The Bottom Line On Rapid7's 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.

Given that Rapid7's revenue growth projections are relatively subdued in comparison to the wider industry, it comes as a surprise to see it trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 4 warning signs for Rapid7 (1 is a bit concerning!) that you need to be mindful of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.