It's not a stretch to say that Southwest Airlines Co.'s (NYSE:LUV) price-to-sales (or "P/S") ratio of 0.6x right now seems quite "middle-of-the-road" for companies in the Airlines industry in the United States, where the median P/S ratio is around 0.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.
How Southwest Airlines Has Been Performing
Southwest Airlines' revenue growth of late has been pretty similar to most other companies. It seems that many are expecting the mediocre revenue performance to persist, which has held the P/S ratio back. If this is the case, then at least existing shareholders won't be losing sleep over the current share price.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Southwest Airlines.
What Are Revenue Growth Metrics Telling Us About The P/S?
Southwest Airlines' 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 7.5%. The latest three year period has also seen an excellent 174% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.
Looking ahead now, revenue is anticipated to climb by 5.6% each year during the coming three years according to the analysts following the company. With the industry predicted to deliver 115% growth per annum, the company is positioned for a weaker revenue result.
With this information, we find it interesting that Southwest Airlines is trading at a fairly similar P/S compared to the industry. 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
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.
Our look at the analysts forecasts of Southwest Airlines' revenue prospects has shown that its inferior revenue outlook isn't negatively impacting its P/S as much as we would have predicted. At present, we aren't confident in the P/S as the predicted future revenues aren't likely to support a more positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.
Before you settle on your opinion, we've discovered 3 warning signs for Southwest Airlines (2 are potentially serious!) that you should be aware of.
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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