When close to half the companies in the Diversified Financial industry in the United States have price-to-sales ratios (or "P/S") below 2.5x, you may consider Acacia Research Corporation (NASDAQ:ACTG) as a stock to potentially avoid with its 3.6x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

How Has Acacia Research Performed Recently?

Acacia Research certainly has been doing a good job lately as it's been growing revenue more 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.

Is There Enough Revenue Growth Forecasted For Acacia Research?

In order to justify its P/S ratio, Acacia Research would need to produce impressive growth in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 122%. This great performance means it was also able to deliver immense revenue growth over the last three years. Accordingly, shareholders would have been over the moon with those medium-term rates of revenue growth.

Turning to the outlook, the next year should bring diminished returns, with revenue decreasing 20% as estimated by the lone analyst watching the company. Meanwhile, the broader industry is forecast to expand by 3.0%, which paints a poor picture.

With this in mind, we find it intriguing that Acacia Research's P/S is closely matching its industry peers. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining revenues are likely to weigh heavily on the share price eventually.

What We Can Learn From Acacia Research's P/S?

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Acacia Research's analyst forecasts revealed that its shrinking revenue outlook isn't drawing down its high P/S anywhere near as much as we would have predicted. Right now we aren't comfortable with the high P/S as the predicted future revenue decline likely to impact the positive sentiment that's propping up the P/S. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Acacia Research, and understanding should be part of your investment process.

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).

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com