The Price Is Right For Shopify Inc. (NYSE:SHOP)

Shopify Inc.'s (NYSE:SHOP) price-to-sales (or "P/S") ratio of 14.3x may look like a poor investment opportunity when you consider close to half the companies in the IT industry in the United States have P/S ratios below 1.8x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Shopify

How Shopify Has Been Performing

Recent times have been advantageous for Shopify as its revenues have been rising faster than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

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

Shopify's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 26%. Pleasingly, revenue has also lifted 141% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 21% each year over the next three years. With the industry only predicted to deliver 12% per year, the company is positioned for a stronger revenue result.

With this information, we can see why Shopify is trading at such a high P/S compared to the industry. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

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.

Our look into Shopify shows that its P/S ratio remains high on the merit of its strong future revenues. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - Shopify has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Shopify's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.