Dynatrace, Inc.'s (NYSE:DT) price-to-sales (or "P/S") ratio of 9.8x might make it look like a strong sell right now compared to the Software industry in the United States, where around half of the companies have P/S ratios below 4.5x and even P/S below 1.7x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Dynatrace's Recent Performance Look Like?

With revenue growth that's superior to most other companies of late, Dynatrace has been doing relatively well. 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 Dynatrace?

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

Taking a look back first, we see that the company grew revenue by an impressive 22% last year. The strong recent performance means it was also able to grow revenue by 98% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 17% each year over the next three years. That's shaping up to be materially lower than the 19% per annum growth forecast for the broader industry.

In light of this, it's alarming that Dynatrace's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've concluded that Dynatrace currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. The weakness in the company's revenue estimate doesn't bode well for the elevated P/S, which could take a fall if the revenue sentiment doesn't improve. At these price levels, investors should remain cautious, particularly if things don't improve.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Dynatrace with six simple checks.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.