With a price-to-sales (or "P/S") ratio of 13.8x Guidewire Software, Inc. (NYSE:GWRE) 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 5.3x and even P/S lower than 2x are not unusual. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Guidewire Software's Recent Performance Look Like?

Recent times haven't been great for Guidewire Software as its revenue has been rising slower than most other companies. It might be that many expect the uninspiring revenue performance to recover significantly, which has kept the P/S ratio from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

Keen to find out how analysts think Guidewire Software's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Revenue Growth Metrics Telling Us About The High P/S?

The only time you'd be truly comfortable seeing a P/S as steep as Guidewire Software's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a decent 13% gain to the company's revenues. Pleasingly, revenue has also lifted 40% in aggregate from three years ago, partly thanks to the last 12 months of growth. 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 15% each year over the next three years. With the industry predicted to deliver 21% growth per annum, the company is positioned for a weaker revenue result.

With this information, we find it concerning that Guidewire Software is trading at a P/S higher than the industry. 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. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

What Does Guidewire Software's P/S Mean For Investors?

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.

We've concluded that Guidewire Software 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Guidewire Software that you should be aware of.

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.

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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.