Elastic N.V.'s (NYSE:ESTC) Shareholders Might Be Looking For Exit

Elastic N.V.'s (NYSE:ESTC) price-to-sales (or "P/S") ratio of 6.3x might make it look like a sell right now compared to the Software industry in the United States, where around half of the companies have P/S ratios below 4.8x and even P/S below 1.8x are quite common. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Elastic

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

With revenue growth that's superior to most other companies of late, Elastic has been doing relatively well. 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 Elastic.

Do Revenue Forecasts Match The High P/S Ratio?

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

If we review the last year of revenue growth, the company posted a terrific increase of 19%. The strong recent performance means it was also able to grow revenue by 96% in total over the last three years. 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 15% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 20% per annum growth forecast for the broader industry.

In light of this, it's alarming that Elastic'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

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've concluded that Elastic currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Elastic (1 is a bit unpleasant!) that you should be aware of before investing here.

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.