Adagene Inc. (NASDAQ:ADAG) shares have continued their recent momentum with a 40% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 48%.

Even after such a large jump in price, Adagene's price-to-sales (or "P/S") ratio of 5.1x might still make it look like a strong buy right now compared to the wider Biotechs industry in the United States, where around half of the companies have P/S ratios above 13.7x and even P/S above 56x are quite common. However, the P/S might be quite low for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Adagene

What Does Adagene's P/S Mean For Shareholders?

With revenue growth that's superior to most other companies of late, Adagene has been doing relatively well. One possibility is that the P/S ratio is low because investors think this strong revenue performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Do Revenue Forecasts Match The Low P/S Ratio?

There's an inherent assumption that a company should far underperform the industry for P/S ratios like Adagene's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 78% gain to the company's top line. 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.

Looking ahead now, revenue is anticipated to slump, contracting by 100% per annum during the coming three years according to the lone analyst following the company. With the industry predicted to deliver 240% growth each year, that's a disappointing outcome.

In light of this, it's understandable that Adagene's P/S would sit below the majority of other companies. However, shrinking revenues are unlikely to lead to a stable P/S over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

Even after such a strong price move, Adagene's P/S still trails the rest of 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.

With revenue forecasts that are inferior to the rest of the industry, it's no surprise that Adagene's P/S is on the lower end of the spectrum. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

You always need to take note of risks, for example - Adagene has 3 warning signs we think you should be aware of.

If you're unsure about the strength of Adagene's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.