Hunan Er-Kang Pharmaceutical Co., Ltd (SZSE:300267) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 19% over that time.

After such a large jump in price, you could be forgiven for thinking Hunan Er-Kang Pharmaceutical is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.7x, considering almost half the companies in China's Pharmaceuticals industry have P/S ratios below 3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Hunan Er-Kang Pharmaceutical's Recent Performance Look Like?

For example, consider that Hunan Er-Kang 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

The only time you'd be truly comfortable seeing a P/S as high as Hunan Er-Kang Pharmaceutical's is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered a frustrating 24% decrease to the company's top line. As a result, revenue from three years ago have also fallen 35% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

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

In light of this, it's alarming that Hunan Er-Kang Pharmaceutical'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.

What Does Hunan Er-Kang Pharmaceutical's P/S Mean For Investors?

The large bounce in Hunan Er-Kang Pharmaceutical's shares has lifted the company's P/S handsomely. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Hunan Er-Kang Pharmaceutical 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.

Having said that, be aware Hunan Er-Kang Pharmaceutical is showing 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

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.