There wouldn't be many who think Pegasystems Inc.'s (NASDAQ:PEGA) price-to-sales (or "P/S") ratio of 4.6x is worth a mention when the median P/S for the Software industry in the United States is similar at about 4.8x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

How Pegasystems Has Been Performing

Recent times haven't been great for Pegasystems as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is moderate because investors think this lacklustre revenue performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

Do Revenue Forecasts Match The P/S Ratio?

Pegasystems' 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 worthy increase of 9.3%. The latest three year period has also seen a 24% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 6.4% per year as estimated by the ten analysts watching the company. With the industry predicted to deliver 20% growth each year, the company is positioned for a weaker revenue result.

With this in mind, we find it intriguing that Pegasystems' P/S is closely matching its industry peers. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of revenue growth is likely to weigh down the shares eventually.

The Key Takeaway

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our look at the analysts forecasts of Pegasystems' revenue prospects has shown that its inferior revenue outlook isn't negatively impacting its P/S as much as we would have predicted. 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. Circumstances like this present a risk to current and prospective investors who may see share prices fall if the low revenue growth impacts the sentiment.

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

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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