You may think that with a price-to-sales (or "P/S") ratio of 7.5x PDF Solutions, Inc. (NASDAQ:PDFS) is a stock to avoid completely, seeing as almost half of all the Semiconductor companies in the United States have P/S ratios under 4.2x and even P/S lower than 1.9x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How PDF Solutions Has Been Performing

With revenue growth that's inferior to most other companies of late, PDF Solutions has been relatively sluggish. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a decent 12% gain to the company's revenues. Pleasingly, revenue has also lifted 88% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenues over that time.

Shifting to the future, estimates from the four analysts covering the company suggest revenue should grow by 10% over the next year. Meanwhile, the rest of the industry is forecast to expand by 44%, which is noticeably more attractive.

With this in consideration, we believe it doesn't make sense that PDF Solutions' P/S is outpacing its industry peers. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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

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.

It comes as a surprise to see PDF Solutions trade at such a high P/S given the revenue forecasts look less than stellar. 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.