Chongqing Lummy Pharmaceutical Co., Ltd. (SZSE:300006) shareholders won't be pleased to see that the share price has had a very rough month, dropping 36% and undoing the prior period's positive performance. The recent drop has obliterated the annual return, with the share price now down 5.4% over that longer period.

In spite of the heavy fall in price, you could still be forgiven for thinking Chongqing Lummy Pharmaceutical is a stock not worth researching with a price-to-sales ratios (or "P/S") of 4.3x, considering almost half the companies in China's Pharmaceuticals industry have P/S ratios below 3.4x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Chongqing Lummy Pharmaceutical's Recent Performance Look Like?

It looks like revenue growth has deserted Chongqing Lummy Pharmaceutical recently, which is not something to boast about. It might be that many are expecting an improvement to the uninspiring revenue performance over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. This isn't what shareholders were looking for as it means they've been left with a 39% decline in revenue over the last three years in total. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 191% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Chongqing Lummy Pharmaceutical's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Bottom Line On Chongqing Lummy Pharmaceutical's P/S

Despite the recent share price weakness, Chongqing Lummy Pharmaceutical's P/S remains higher than most other companies in the industry. 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.

We've established that Chongqing Lummy Pharmaceutical currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Chongqing Lummy Pharmaceutical (1 can't be ignored!) that you should be aware of before investing here.

If you're unsure about the strength of Chongqing Lummy Pharmaceutical'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.