There's Reason For Concern Over Workday, Inc.'s (NASDAQ:WDAY) Massive 25% Price Jump

Workday, Inc. (NASDAQ:WDAY) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 3.3% isn't as impressive.

Following the firm bounce in price, Workday may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 8.5x, when you consider almost half of the companies in the Software industry in the United States have P/S ratios under 4.8x 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.

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Check out our latest analysis for Workday

How Workday Has Been Performing

Recent revenue growth for Workday has been in line with the industry. It might be that many expect the mediocre revenue performance to strengthen positively, which has kept the P/S ratio from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Revenue Growth Forecasted For Workday?

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

Taking a look back first, we see that the company grew revenue by an impressive 16% last year. The strong recent performance means it was also able to grow revenue by 64% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 13% per year over the next three years. With the industry predicted to deliver 16% growth per annum, the company is positioned for a weaker revenue result.

With this information, we find it concerning that Workday is trading at a P/S higher than the industry. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

The strong share price surge has lead to Workday's P/S soaring as well. 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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Workday, this doesn't appear to be impacting the P/S in the slightest. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Workday that you should be aware of.

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