Grace Life-tech Holdings Limited (HKG:2112) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 49% in that time.

In spite of the heavy fall in price, given close to half the companies operating in Hong Kong's Trade Distributors industry have price-to-sales ratios (or "P/S") below 0.6x, you may still consider Grace Life-tech Holdings as a stock to potentially avoid with its 2.2x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

View our latest analysis for Grace Life-tech Holdings

How Has Grace Life-tech Holdings Performed Recently?

For instance, Grace Life-tech Holdings' receding revenue in recent times would have to be some food for thought. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Grace Life-tech Holdings' to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 32%. The last three years don't look nice either as the company has shrunk revenue by 88% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 4.9% shows it's an unpleasant look.

With this information, we find it concerning that Grace Life-tech Holdings is trading at a P/S higher than 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 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.

What Does Grace Life-tech Holdings' P/S Mean For Investors?

Despite the recent share price weakness, Grace Life-tech Holdings' P/S remains higher than most other companies in the industry. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Grace Life-tech Holdings currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Plus, you should also learn about these 3 warning signs we've spotted with Grace Life-tech Holdings (including 2 which make us uncomfortable).

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.