When you see that almost half of the companies in the Pharmaceuticals industry in China have price-to-sales ratios (or "P/S") below 3.2x, Zhejiang Wecome Pharmaceutical Company Limited (SZSE:300878) looks to be giving off strong sell signals with its 6.3x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Zhejiang Wecome Pharmaceutical

How Has Zhejiang Wecome Pharmaceutical Performed Recently?

For example, consider that Zhejiang Wecome Pharmaceutical's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Zhejiang Wecome Pharmaceutical's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 19% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 26% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 37% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Zhejiang Wecome Pharmaceutical is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

The Final Word

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zhejiang Wecome Pharmaceutical currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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 8 warning signs we've spotted with Zhejiang Wecome Pharmaceutical (including 4 which are potentially serious).

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.