Why Investors Shouldn't Be Surprised By Zscaler, Inc.'s (NASDAQ:ZS) P/S

You may think that with a price-to-sales (or "P/S") ratio of 14x Zscaler, Inc. (NASDAQ:ZS) is a stock to avoid completely, seeing as almost half of all the Software companies in the United States have P/S ratios under 4.3x and even P/S lower than 1.6x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Zscaler

How Zscaler Has Been Performing

With revenue growth that's superior to most other companies of late, Zscaler has been doing relatively well. The P/S is probably high because investors think this strong revenue performance will continue. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on analyst estimates for the company? Then our free report on Zscaler will help you uncover what's on the horizon.

Is There Enough Revenue Growth Forecasted For Zscaler?

The only time you'd be truly comfortable seeing a P/S as steep as Zscaler's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 41% gain to the company's top line. Pleasingly, revenue has also lifted 254% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Looking ahead now, revenue is anticipated to climb by 26% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to only expand by 15% per year, which is noticeably less attractive.

In light of this, it's understandable that Zscaler's P/S sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our look into Zscaler 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. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Zscaler you should know about.

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.