Revenues Tell The Story For Sprout Social, Inc. (NASDAQ:SPT)

Sprout Social, Inc.'s (NASDAQ:SPT) 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 4.1x and even P/S below 1.5x are quite common. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Sprout Social

How Has Sprout Social Performed Recently?

With revenue growth that's superior to most other companies of late, Sprout Social has been doing relatively well. 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.

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

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

Sprout Social's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered an exceptional 31% gain to the company's top line. The latest three year period has also seen an excellent 151% 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.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 28% per annum over the next three years. That's shaping up to be materially higher than the 15% per annum growth forecast for the broader industry.

With this in mind, it's not hard to understand why Sprout Social's P/S is high relative to its industry peers. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What Does Sprout Social's P/S Mean For Investors?

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Sprout Social maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Software industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Sprout Social that you need to be mindful of.

If these risks are making you reconsider your opinion on Sprout Social, 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.