Modern Chinese Medicine Group Co., Ltd. (HKG:1643) shares have continued their recent momentum with a 30% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 36% in the last year.

In spite of the firm bounce in price, there still wouldn't be many who think Modern Chinese Medicine Group's price-to-sales (or "P/S") ratio of 1.1x is worth a mention when the median P/S in Hong Kong's Pharmaceuticals industry is similar at about 1.5x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

How Modern Chinese Medicine Group Has Been Performing

For instance, Modern Chinese Medicine Group's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is moderate because investors think the company might still do enough to be in line with the broader industry in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Is There Some Revenue Growth Forecasted For Modern Chinese Medicine Group?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Modern Chinese Medicine Group's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 37%. The last three years don't look nice either as the company has shrunk revenue by 25% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 10% shows it's an unpleasant look.

With this information, we find it concerning that Modern Chinese Medicine Group is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the recent poor growth rate 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 the recent negative growth rates.

The Key Takeaway

Modern Chinese Medicine Group appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry 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 Modern Chinese Medicine Group 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. Even though it matches the industry, we're uncomfortable with the current P/S ratio, as this dismal revenue performance is unlikely to support a more positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Modern Chinese Medicine Group (of which 2 are potentially serious!) you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.