Guangdong Lifestrong Pharmacy Co., Ltd. (SZSE:301111) shareholders won't be pleased to see that the share price has had a very rough month, dropping 28% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 16% share price drop.

Even after such a large drop in price, given around half the companies in China's Pharmaceuticals industry have price-to-sales ratios (or "P/S") below 3.3x, you may still consider Guangdong Lifestrong Pharmacy as a stock to avoid entirely with its 10x 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.

Check out our latest analysis for Guangdong Lifestrong Pharmacy

What Does Guangdong Lifestrong Pharmacy's P/S Mean For Shareholders?

For instance, Guangdong Lifestrong Pharmacy's receding revenue in recent times would have to be some food for thought. 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.

Is There Enough Revenue Growth Forecasted For Guangdong Lifestrong Pharmacy?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Guangdong Lifestrong Pharmacy'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 4.7%. The last three years don't look nice either as the company has shrunk revenue by 17% 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 35% shows it's an unpleasant look.

In light of this, it's alarming that Guangdong Lifestrong Pharmacy's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Guangdong Lifestrong Pharmacy's shares may have suffered, but its P/S remains high. 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.

We've established that Guangdong Lifestrong Pharmacy currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Lifestrong Pharmacy, and understanding these should be part of your investment process.

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.