Unpleasant Surprises Could Be In Store For Model N, Inc.'s (NYSE:MODN) Shares

With a median price-to-sales (or "P/S") ratio of close to 5x in the Software industry in the United States, you could be forgiven for feeling indifferent about Model N, Inc.'s (NYSE:MODN) P/S ratio of 5.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

See our latest analysis for Model N

What Does Model N's Recent Performance Look Like?

Recent times haven't been great for Model N as its revenue has been rising slower than most other companies. Perhaps the market is expecting future revenue performance to lift, which has kept the P/S from declining. 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 Model N.

Do Revenue Forecasts Match The P/S Ratio?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 14% last year. The latest three year period has also seen an excellent 58% overall rise in revenue, aided somewhat by its short-term performance. 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 11% per year as estimated by the eleven analysts watching the company. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader industry.

In light of this, it's curious that Model N's P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What We Can Learn From Model N's P/S?

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.

When you consider that Model N's revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. At present, we aren't confident in the P/S as the predicted future revenues aren't likely to support a more positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Model N that you need to be mindful of.

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.