With a price-to-sales (or "P/S") ratio of 7x Smartsheet Inc. (NYSE:SMAR) 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 4.5x and even P/S lower than 1.7x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Smartsheet's P/S Mean For Shareholders?

With revenue growth that's superior to most other companies of late, Smartsheet has been doing relatively well. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered an exceptional 20% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 128% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 16% per year as estimated by the analysts watching the company. With the industry predicted to deliver 20% growth per year, the company is positioned for a weaker revenue result.

With this in consideration, we believe it doesn't make sense that Smartsheet's P/S is outpacing its industry peers. 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 We Can Learn From Smartsheet's P/S?

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've concluded that Smartsheet currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 1 warning sign for Smartsheet that we have uncovered.

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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