Lotus Health Group Company (SHSE:600186) shares have retraced a considerable 27% in the last month, reversing a fair amount of their solid recent performance. Looking at the bigger picture, even after this poor month the stock is up 86% in the last year.

In spite of the heavy fall in price, given around half the companies in China's Food industry have price-to-sales ratios (or "P/S") below 2.1x, you may still consider Lotus Health Group as a stock to avoid entirely with its 5.2x 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.

See our latest analysis for Lotus Health Group

What Does Lotus Health Group's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Lotus Health Group over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Lotus Health Group?

The only time you'd be truly comfortable seeing a P/S as steep as Lotus Health Group's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 1.1% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 9.2% overall rise in revenue. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 17% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Lotus Health Group's P/S exceeds that of its industry peers. 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.

What We Can Learn From Lotus Health Group's P/S?

Even after such a strong price drop, Lotus Health Group's P/S still exceeds the industry median significantly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Lotus Health Group 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 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Lotus Health Group (at least 1 which is a bit concerning), and understanding these 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).

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.