When you see that almost half of the companies in the Pharmaceuticals industry in China have price-to-sales ratios (or "P/S") below 3.4x, GuangYuYuan Chinese Herbal Medicine Co., Ltd. (SHSE:600771) looks to be giving off strong sell signals with its 10.1x 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 so lofty.

What Does GuangYuYuan Chinese Herbal Medicine's Recent Performance Look Like?

The revenue growth achieved at GuangYuYuan Chinese Herbal Medicine over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is GuangYuYuan Chinese Herbal Medicine's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like GuangYuYuan Chinese Herbal Medicine's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 10%. Revenue has also lifted 15% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 19% shows it's noticeably less attractive.

In light of this, it's alarming that GuangYuYuan Chinese Herbal Medicine's P/S sits above the majority of other companies. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does GuangYuYuan Chinese Herbal Medicine's P/S Mean For Investors?

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.

The fact that GuangYuYuan Chinese Herbal Medicine currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 1 warning sign for GuangYuYuan Chinese Herbal Medicine you should be aware of.

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.