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. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Zscaler's Recent Performance Look Like?

Zscaler certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

Zscaler'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.

Retrospectively, the last year delivered an exceptional 41% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 254% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 26% per year over the next three years. With the industry only predicted to deliver 15% each year, the company is positioned for a stronger revenue result.

With this information, we can see why Zscaler is trading at such a high P/S compared to the industry. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

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.

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 the analysts have really missed the mark, these strong revenue forecasts should keep the share price buoyant.

You should always think about risks. Case in point, we've spotted 2 warning signs for Zscaler you should be aware of.

If you're unsure about the strength of Zscaler's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.