Yahoo Finance Risks To Shareholder Returns Are Elevated At These Prices For Xero Limited (ASX:XRO)
When close to half the companies in the Software industry in Australia have price-to-sales ratios (or "P/S") below 2.8x, you may consider Xero Limited (ASX:XRO) as a stock to avoid entirely with its 12.1x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.
Check out our latest analysis for Xero
How Has Xero Performed Recently?
Xero's revenue growth of late has been pretty similar to most other companies. One possibility is that the P/S ratio is high because investors think this modest revenue performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Want the full picture on analyst estimates for the company? Then our free report on Xero will help you uncover what's on the horizon.
Is There Enough Revenue Growth Forecasted For Xero?
There's an inherent assumption that a company should far outperform the industry for P/S ratios like Xero's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 32% gain to the company's top line. The latest three year period has also seen an excellent 97% overall rise in revenue, aided by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.
Shifting to the future, estimates from the analysts covering the company suggest revenue should grow by 19% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 20% per annum, which is not materially different.
With this in consideration, we find it intriguing that Xero's P/S is higher than its industry peers. 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.
Given Xero's future revenue forecasts are in line with the wider industry, the fact that it trades at an elevated P/S is somewhat surprising. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Xero with six simple checks on some of these key factors.
If these risks are making you reconsider your opinion on Xero, explore our interactive list of high quality stocks to get an idea of what else is out there.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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