DigitalOcean Holdings, Inc.'s (NYSE:DOCN) price-to-sales (or "P/S") ratio of 4.6x may look like a poor investment opportunity when you consider close to half the companies in the IT industry in the United States have P/S ratios below 1.9x. 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 DigitalOcean Holdings' Recent Performance Look Like?

Recent times have been advantageous for DigitalOcean Holdings as its revenues have been rising faster than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, DigitalOcean Holdings would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that the company grew revenue by an impressive 16% last year. Pleasingly, revenue has also lifted 110% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Shifting to the future, estimates from the twelve analysts covering the company suggest revenue should grow by 14% per annum over the next three years. That's shaping up to be materially higher than the 12% per annum growth forecast for the broader industry.

With this information, we can see why DigitalOcean Holdings is trading at such a high P/S compared to the industry. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

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.

As we suspected, our examination of DigitalOcean Holdings' analyst forecasts revealed that its superior revenue outlook is contributing to its high P/S. 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.

You should always think about risks. Case in point, we've spotted 4 warning signs for DigitalOcean Holdings you should be aware of, and 2 of them shouldn't be ignored.

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

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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.