With a price-to-sales (or "P/S") ratio of 21.1x ServiceNow, Inc. (NYSE:NOW) may be sending very bearish signals at the moment, given that almost half of all the Software companies in the United States have P/S ratios under 5.5x and even P/S lower than 1.9x are not unusual. 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 ServiceNow's Recent Performance Look Like?

Recent times have been advantageous for ServiceNow as its revenues have been rising faster than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, ServiceNow would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an exceptional 23% gain to the company's top line. The latest three year period has also seen an excellent 89% 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 three years should generate growth of 20% each year as estimated by the analysts watching the company. With the industry predicted to deliver 21% growth per annum, the company is positioned for a comparable revenue result.

With this information, we find it interesting that ServiceNow is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Analysts are forecasting ServiceNow's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 2 warning signs for ServiceNow that you need to take into consideration.

If these risks are making you reconsider your opinion on ServiceNow, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.