SPS Commerce, Inc.'s (NASDAQ:SPSC) price-to-sales (or "P/S") ratio of 14.1x might make it look like a strong sell right now compared to the Software industry in the United States, where around half of the companies have P/S ratios below 4.5x and even P/S below 1.8x are quite common. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for SPS Commerce

How Has SPS Commerce Performed Recently?

SPS Commerce certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For SPS Commerce?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like SPS Commerce's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 19% gain to the company's top line. Pleasingly, revenue has also lifted 70% 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.

Shifting to the future, estimates from the eight analysts covering the company suggest revenue should grow by 16% over the next year. With the industry predicted to deliver 15% growth , the company is positioned for a comparable revenue result.

In light of this, it's curious that SPS Commerce's P/S sits above the majority of other companies. 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.

What Does SPS Commerce's P/S Mean For Investors?

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.

Analysts are forecasting SPS Commerce's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. Unless the company can jump ahead of the rest of the industry in the short-term, it'll be a challenge to maintain the share price at current levels.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for SPS Commerce with six simple checks will allow you to discover any risks that could be an issue.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.