Despite an already strong run, Rhythm Pharmaceuticals, Inc. (NASDAQ:RYTM) shares have been powering on, with a gain of 28% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 93% in the last year.

Since its price has surged higher, Rhythm Pharmaceuticals' price-to-sales (or "P/S") ratio of 33.8x might make it look like a strong sell right now compared to other companies in the Biotechs industry in the United States, where around half of the companies have P/S ratios below 9.9x and even P/S below 4x are quite common. 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 Rhythm Pharmaceuticals' P/S Mean For Shareholders?

Recent times haven't been great for Rhythm Pharmaceuticals as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Rhythm Pharmaceuticals?

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

If we review the last year of revenue growth, the company posted a terrific increase of 82%. This great performance means it was also able to deliver immense revenue growth over the last three years. So we can start by confirming that the company has done a tremendous job of growing revenue over that time.

Turning to the outlook, the next three years should generate growth of 69% per annum as estimated by the eleven analysts watching the company. That's shaping up to be materially lower than the 118% each year growth forecast for the broader industry.

With this information, we find it concerning that Rhythm Pharmaceuticals is trading at a P/S higher than the industry. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Rhythm Pharmaceuticals' P/S?

The strong share price surge has lead to Rhythm Pharmaceuticals' P/S soaring as well. 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.

We've concluded that Rhythm Pharmaceuticals 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

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

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.