There wouldn't be many who think Hunan Er-Kang Pharmaceutical Co., Ltd's (SZSE:300267) price-to-sales (or "P/S") ratio of 2.9x is worth a mention when the median P/S for the Pharmaceuticals industry in China is similar at about 3.2x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

View our latest analysis for Hunan Er-Kang Pharmaceutical

What Does Hunan Er-Kang Pharmaceutical's P/S Mean For Shareholders?

We'd have to say that with no tangible growth over the last year, Hunan Er-Kang Pharmaceutical's revenue has been unimpressive. One possibility is that the P/S is moderate because investors think this benign revenue growth rate might not be enough to outperform the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

How Is Hunan Er-Kang Pharmaceutical's Revenue Growth Trending?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Hunan Er-Kang Pharmaceutical's to be considered reasonable.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 22% decline in revenue over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 37% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Hunan Er-Kang Pharmaceutical is trading at a fairly similar P/S compared to the industry. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. 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 the recent negative growth rates.

What We Can Learn From Hunan Er-Kang Pharmaceutical's P/S?

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 look at Hunan Er-Kang Pharmaceutical revealed its shrinking revenues over the medium-term haven't impacted the P/S as much as we anticipated, given the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Hunan Er-Kang Pharmaceutical (at least 2 which shouldn't be ignored), and understanding these should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.