With a price-to-sales (or "P/S") ratio of 27.8x AppLovin Corporation (NASDAQ:APP) 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 5.6x 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 AppLovin's Recent Performance Look Like?

AppLovin certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For AppLovin?

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

Taking a look back first, we see that the company grew revenue by an impressive 41% last year. The strong recent performance means it was also able to grow revenue by 71% 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 23% per annum 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 AppLovin is trading at a high P/S compared to the industry. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Final Word

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.

Given AppLovin's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. A positive change is needed in order to justify the current price-to-sales ratio.

You always need to take note of risks, for example - AppLovin has 3 warning signs we think 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.