You may think that with a price-to-sales (or "P/S") ratio of 5.9x Hangzhou Alltest Biotech Co., Ltd. (SHSE:688606) is a stock to potentially avoid, seeing as almost half of all the Medical Equipment companies in China have P/S ratios under 4.9x and even P/S lower than 2x aren't out of the ordinary. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Hangzhou Alltest Biotech's Recent Performance Look Like?

For example, consider that Hangzhou Alltest Biotech's financial performance has been poor lately as its revenue has been in decline. 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.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Hangzhou Alltest Biotech would need to produce impressive growth 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 27%. As a result, revenue from three years ago have also fallen 41% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 27% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Hangzhou Alltest Biotech'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. 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 Final Word

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Hangzhou Alltest Biotech 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.

It is also worth noting that we have found 3 warning signs for Hangzhou Alltest Biotech (2 make us uncomfortable!) that you need to take into consideration.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.