There wouldn't be many who think Shanghai New World Co., Ltd's (SHSE:600628) price-to-sales (or "P/S") ratio of 3.9x is worth a mention when the median P/S for the Pharmaceuticals industry in China is similar at about 3.5x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

How Shanghai New World Has Been Performing

Revenue has risen firmly for Shanghai New World recently, which is pleasing to see. One possibility is that the P/S is moderate because investors think this respectable revenue growth might not be enough to outperform the broader industry in the near future. Those who are bullish on Shanghai New World will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

How Is Shanghai New World's Revenue Growth Trending?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Shanghai New World's to be considered reasonable.

Retrospectively, the last year delivered a decent 8.9% gain to the company's revenues. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 2.3% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 142% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's somewhat alarming that Shanghai New World's P/S sits in line with 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 on the share price eventually.

The Bottom Line On Shanghai New World's P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We find it unexpected that Shanghai New World trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Shanghai New World is showing 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.