With a median price-to-sales (or "P/S") ratio of close to 4.8x in the Software industry in the United States, you could be forgiven for feeling indifferent about Sprout Social, Inc.'s (NASDAQ:SPT) P/S ratio of 4.5x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

What Does Sprout Social's Recent Performance Look Like?

Sprout Social certainly has been doing a good job lately as it's been growing revenue more than most other companies. Perhaps the market is expecting this level of performance to taper off, keeping the P/S from soaring. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

How Is Sprout Social's Revenue Growth Trending?

Sprout Social's P/S ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 30%. The latest three year period has also seen an excellent 140% overall rise in revenue, aided by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 17% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 20% per year growth forecast for the broader industry.

With this information, we find it interesting that Sprout Social is trading at a fairly similar P/S compared to the industry. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Sprout Social's P/S

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.

Given that Sprout Social's revenue growth projections are relatively subdued in comparison to the wider industry, it comes as a surprise to see it trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about these 2 warning signs we've spotted with Sprout Social.

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.