Workday, Inc.'s (NASDAQ:WDAY) Business Is Trailing The Industry But Its Shares Aren't

With a price-to-sales (or "P/S") ratio of 7.5x Workday, Inc. (NASDAQ:WDAY) may be sending very bearish signals at the moment, given that almost half of all the Software companies in the United States have P/S ratios under 4.4x and even P/S lower than 1.6x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Workday

What Does Workday's Recent Performance Look Like?

Recent revenue growth for Workday has been in line with the industry. One possibility is that the P/S ratio is high because investors think this modest revenue performance will accelerate. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

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.

If we review the last year of revenue growth, the company posted a terrific increase of 17%. Pleasingly, revenue has also lifted 69% in aggregate from three years ago, thanks to the last 12 months of growth. 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 15% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 14% per annum, which is not materially different.

With this information, we find it interesting that Workday is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

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 Workday's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. 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.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Workday with six simple checks.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com