When close to half the companies in the Insurance industry in the United States have price-to-sales ratios (or "P/S") below 1.1x, you may consider Goosehead Insurance, Inc (NASDAQ:GSHD) as a stock to avoid entirely with its 5.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Goosehead Insurance's P/S Mean For Shareholders?

Goosehead Insurance's revenue growth of late has been pretty similar to most other companies. One possibility is that the P/S ratio is high because investors think this modest revenue performance will accelerate. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

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

Taking a look back first, we see that the company grew revenue by an impressive 19% last year. The strong recent performance means it was also able to grow revenue by 110% in total over the last three years. So we can start by confirming that the company has done a great job of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 33% each year during the coming three years according to the nine analysts following the company. Meanwhile, the rest of the industry is forecast to only expand by 5.0% each year, which is noticeably less attractive.

In light of this, it's understandable that Goosehead Insurance's P/S sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What Does Goosehead Insurance's P/S Mean For Investors?

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.

We've established that Goosehead Insurance maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Insurance industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Having said that, be aware Goosehead Insurance is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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.