With a price-to-sales (or "P/S") ratio of 8.6x Sprout Social, Inc. (NASDAQ:SPT) may be sending very bearish signals at the moment, given that almost half of all the Software companies in the United States have P/S ratios under 4.1x and even P/S lower than 1.5x are not unusual. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Sprout Social's Recent Performance Look Like?

With revenue growth that's superior to most other companies of late, Sprout Social has been doing relatively well. 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.

How Is Sprout Social's Revenue Growth Trending?

Sprout Social's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that the company grew revenue by an impressive 31% last year. The strong recent performance means it was also able to grow revenue by 151% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Looking ahead now, revenue is anticipated to climb by 28% per annum during the coming three years according to the analysts following the company. With the industry only predicted to deliver 15% per year, the company is positioned for a stronger revenue result.

With this in mind, it's not hard to understand why Sprout Social's P/S is high relative to its industry peers. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Sprout Social's P/S

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.

As we suspected, our examination of Sprout Social's analyst forecasts revealed that its superior revenue outlook is contributing to its high P/S. It appears that shareholders are confident in the company's future revenues, which is propping up the P/S. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Sprout Social 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.