With a price-to-sales (or "P/S") ratio of 28x Rhythm Pharmaceuticals, Inc. (NASDAQ:RYTM) may be sending very bearish signals at the moment, given that almost half of all the Biotechs companies in the United States have P/S ratios under 11.9x and even P/S lower than 4x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Rhythm Pharmaceuticals Performed Recently?

With revenue growth that's superior to most other companies of late, Rhythm Pharmaceuticals has been doing relatively well. The P/S is probably high because investors think this strong revenue performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

How Is Rhythm Pharmaceuticals' Revenue Growth Trending?

In order to justify its P/S ratio, Rhythm Pharmaceuticals would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 174%. Spectacularly, three year revenue growth has ballooned by several orders of magnitude, thanks in part to the last 12 months of revenue growth. 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 68% each year as estimated by the nine analysts watching the company. That's shaping up to be materially lower than the 209% each year growth forecast for the broader industry.

In light of this, it's alarming that Rhythm Pharmaceuticals' P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.

The Bottom Line On Rhythm Pharmaceuticals' P/S

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.

It comes as a surprise to see Rhythm Pharmaceuticals trade at such a high P/S given the revenue forecasts look less than stellar. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for Rhythm Pharmaceuticals that we have uncovered.

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.