Extreme Networks, Inc.'s (NASDAQ:EXTR) Price Is Out Of Tune With Revenues

When close to half the companies in the Communications industry in the United States have price-to-sales ratios (or "P/S") below 1.3x, you may consider Extreme Networks, Inc. (NASDAQ:EXTR) as a stock to potentially avoid with its 2.2x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

See our latest analysis for Extreme Networks

How Has Extreme Networks Performed Recently?

While the industry has experienced revenue growth lately, Extreme Networks' revenue has gone into reverse gear, which is not great. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. If not, then existing shareholders may be extremely 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 Extreme Networks.

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

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 24% decrease to the company's top line. This has erased any of its gains during the last three years, with practically no change in revenue being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the seven analysts covering the company suggest revenue should grow by 11% over the next year. That's shaping up to be similar to the 11% growth forecast for the broader industry.

With this information, we find it interesting that Extreme Networks is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Final Word

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Analysts are forecasting Extreme Networks' revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Extreme Networks with six simple checks on some of these key factors.

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.