GuangYuYuan Chinese Herbal Medicine Co., Ltd.'s (SHSE:600771) price-to-sales (or "P/S") ratio of 11.9x may look like a poor investment opportunity when you consider close to half the companies in the Pharmaceuticals industry in China have P/S ratios below 3.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for GuangYuYuan Chinese Herbal Medicine

How GuangYuYuan Chinese Herbal Medicine Has Been Performing

GuangYuYuan Chinese Herbal Medicine has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is GuangYuYuan Chinese Herbal Medicine's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like GuangYuYuan Chinese Herbal Medicine's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 2.8%. Revenue has also lifted 5.8% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 40% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that GuangYuYuan Chinese Herbal Medicine is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Bottom Line On GuangYuYuan Chinese Herbal Medicine's P/S

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

The fact that GuangYuYuan Chinese Herbal Medicine currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for GuangYuYuan Chinese Herbal Medicine that we have uncovered.

If you're unsure about the strength of GuangYuYuan Chinese Herbal Medicine's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.