Sprout Social, Inc.'s (NASDAQ:SPT) Shares Climb 27% But Its Business Is Yet to Catch Up

The Sprout Social, Inc. (NASDAQ:SPT) share price has done very well over the last month, posting an excellent gain of 27%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 43% in the last twelve months.

Although its price has surged higher, it's still not a stretch to say that Sprout Social's price-to-sales (or "P/S") ratio of 5.3x right now seems quite "middle-of-the-road" compared to the Software industry in the United States, where the median P/S ratio is around 5.7x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Check out our latest analysis for Sprout Social

What Does Sprout Social's Recent Performance Look Like?

Recent times have been advantageous for Sprout Social as its revenues have been rising faster 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 not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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 P/S?

Sprout Social's P/S ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the industry.

Retrospectively, the last year delivered an exceptional 27% gain to the company's top line. The latest three year period has also seen an excellent 128% 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 14% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 20% each year growth forecast for the broader industry.

In light of this, it's curious that Sprout Social's P/S sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. 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 Sprout Social's P/S

Its shares have lifted substantially and now Sprout Social's P/S is back within range of the industry median. 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 that Sprout Social'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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Sprout Social that you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.