Digimarc Corporation (NASDAQ:DMRC) shares have had a horrible month, losing 28% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 30% share price drop.

Although its price has dipped substantially, Digimarc may still be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 13.3x, when you consider almost half of the companies in the Software industry in the United States have P/S ratios under 4.7x and even P/S lower than 1.6x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Digimarc Performed Recently?

Recent times have been advantageous for Digimarc 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. 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?

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

Taking a look back first, we see that the company grew revenue by an impressive 22% last year. The latest three year period has also seen an excellent 59% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next year should generate growth of 19% as estimated by the two analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 21%, which is not materially different.

In light of this, it's curious that Digimarc's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Key Takeaway

A significant share price dive has done very little to deflate Digimarc's very lofty 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.

Given Digimarc's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 3 warning signs for Digimarc you should be aware of.

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.