Kunming Longjin Pharmaceutical Co., Ltd. (SZSE:002750) shareholders are no doubt pleased to see that the share price has bounced 37% in the last month, although it is still struggling to make up recently lost ground. But the last month did very little to improve the 76% share price decline over the last year.

After such a large jump in price, given around half the companies in China's Pharmaceuticals industry have price-to-sales ratios (or "P/S") below 2.9x, you may consider Kunming Longjin Pharmaceutical as a stock to avoid entirely with its 9.9x 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 Kunming Longjin Pharmaceutical's Recent Performance Look Like?

For instance, Kunming Longjin Pharmaceutical'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.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a frustrating 5.7% 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 78% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 17% shows it's an unpleasant look.

With this in mind, we find it worrying that Kunming Longjin Pharmaceutical's P/S exceeds that of its industry peers. 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 Bottom Line On Kunming Longjin Pharmaceutical's P/S

The strong share price surge has lead to Kunming Longjin Pharmaceutical's P/S soaring as well. 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.

Our examination of Kunming Longjin Pharmaceutical revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Kunming Longjin Pharmaceutical that 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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