When you see that almost half of the companies in the Interactive Media and Services industry in the United States have price-to-sales ratios (or "P/S") below 1.6x, CarGurus, Inc. (NASDAQ:CARG) looks to be giving off some sell signals with its 2.7x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

What Does CarGurus' P/S Mean For Shareholders?

CarGurus could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is CarGurus' Revenue Growth Trending?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 45%. Even so, admirably revenue has lifted 66% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 7.4% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader industry.

In light of this, it's alarming that CarGurus' 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 Bottom Line On CarGurus' P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've concluded that CarGurus currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for CarGurus you should be aware of.

If these risks are making you reconsider your opinion on CarGurus, explore our interactive list of high quality stocks to get an idea of what else is out there.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.