Zscaler, Inc.'s (NASDAQ:ZS) 27% Share Price Plunge Could Signal Some Risk

Zscaler, Inc. (NASDAQ:ZS) shareholders won't be pleased to see that the share price has had a very rough month, dropping 27% and undoing the prior period's positive performance. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 22%.

Even after such a large drop in price, Zscaler may still be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 13.7x, when you consider almost half of the companies in the Software industry in the United States have P/S ratios under 4.7x and even P/S lower than 2x 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 Zscaler

What Does Zscaler's P/S Mean For Shareholders?

Zscaler certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

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

The only time you'd be truly comfortable seeing a P/S as steep as Zscaler's is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a terrific increase of 23%. The latest three year period has also seen an excellent 133% overall rise in revenue, aided by its short-term performance. 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 20% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 30% per year, which is noticeably more attractive.

In light of this, it's alarming that Zscaler's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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

Zscaler's shares may have suffered, but its P/S remains high. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

It comes as a surprise to see Zscaler trade at such a high P/S given the revenue forecasts look less than stellar. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. At these price levels, investors should remain cautious, particularly if things don't improve.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Zscaler that you should be aware 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.