When close to half the companies in the Pharmaceuticals industry in China have price-to-sales ratios (or "P/S") below 3x, you may consider Shanghai Shen Lian Biomedical Corporation (SHSE:688098) as a stock to avoid entirely with its 8.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Shanghai Shen Lian Biomedical's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Shanghai Shen Lian Biomedical over the last year, which is not ideal at all. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 24%. The last three years don't look nice either as the company has shrunk revenue by 15% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 35% 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 Shanghai Shen Lian Biomedical 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 Key Takeaway

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Shanghai Shen Lian Biomedical 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Shanghai Shen Lian Biomedical (2 are potentially serious!) that you should be aware of before investing here.

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.