Extreme Networks, Inc.'s (NASDAQ:EXTR) Popularity With Investors Is Under Threat From Overpricing

Extreme Networks, Inc.'s (NASDAQ:EXTR) price-to-sales (or "P/S") ratio of 1.8x may not look like an appealing investment opportunity when you consider close to half the companies in the Communications industry in the United States have P/S ratios below 1.1x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Extreme Networks

How Extreme Networks Has Been Performing

Extreme Networks could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Keen to find out how analysts think Extreme Networks' future stacks up against the industry? In that case, our free report is a great place to start.

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 Extreme Networks' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 15% decrease to the company's top line. Regardless, revenue has managed to lift by a handy 11% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 3.1% each year as estimated by the seven analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 9.4% each year, which is noticeably more attractive.

In light of this, it's alarming that Extreme Networks' P/S sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Key Takeaway

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.

It comes as a surprise to see Extreme Networks 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Extreme Networks with six simple checks will allow you to discover any risks that could be an issue.

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.