When you see that almost half of the companies in the Pharmaceuticals industry in China have price-to-sales ratios (or "P/S") below 3x, Kangmei Pharmaceutical Co., Ltd. (SHSE:600518) looks to be giving off some sell signals with its 4.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Has Kangmei Pharmaceutical Performed Recently?

The recent revenue growth at Kangmei Pharmaceutical would have to be considered satisfactory if not spectacular. 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. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Kangmei Pharmaceutical?

Kangmei Pharmaceutical's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 4.0%. Still, revenue has barely risen at all in aggregate from three years ago, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the industry, which is expected to grow by 18% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Kangmei Pharmaceutical's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Final Word

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.

Our examination of Kangmei Pharmaceutical revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Kangmei Pharmaceutical, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Kangmei Pharmaceutical, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.