DigitalOcean Holdings, Inc.'s (NYSE:DOCN) Shares Climb 26% But Its Business Is Yet to Catch Up

DigitalOcean Holdings, Inc. (NYSE:DOCN) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, despite the strong performance over the last month, the full year gain of 2.2% isn't as attractive.

Since its price has surged higher, when almost half of the companies in the United States' IT industry have price-to-sales ratios (or "P/S") below 1.7x, you may consider DigitalOcean Holdings as a stock probably not worth researching with its 3.7x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for DigitalOcean Holdings

What Does DigitalOcean Holdings' P/S Mean For Shareholders?

DigitalOcean Holdings certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

How Is DigitalOcean Holdings' Revenue Growth Trending?

In order to justify its P/S ratio, DigitalOcean Holdings would need to produce impressive growth in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 27%. The strong recent performance means it was also able to grow revenue by 112% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Looking ahead now, revenue is anticipated to climb by 13% per year during the coming three years according to the twelve analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 13% each year, which is not materially different.

With this in consideration, we find it intriguing that DigitalOcean Holdings' P/S is higher than its industry peers. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

What We Can Learn From DigitalOcean Holdings' P/S?

DigitalOcean Holdings shares have taken a big step in a northerly direction, but its P/S is elevated as a result. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that DigitalOcean Holdings currently trades on a higher than expected P/S. 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about these 2 warning signs we've spotted with DigitalOcean Holdings (including 1 which is a bit concerning).

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.