Shanghai Shen Lian Biomedical Corporation (SHSE:688098) shareholders have had their patience rewarded with a 44% share price jump in the last month. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 25% in the last twelve months.

After such a large jump in price, you could be forgiven for thinking Shanghai Shen Lian Biomedical is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.4x, considering almost half the companies in China's Pharmaceuticals industry have P/S ratios below 3.5x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Shanghai Shen Lian Biomedical's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Shanghai Shen Lian Biomedical over the last year, which is not ideal at all. 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. 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?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai Shen Lian Biomedical's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 2.7%. The last three years don't look nice either as the company has shrunk revenue by 9.3% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 141% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Shanghai Shen Lian Biomedical'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. 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 Key Takeaway

Shares in Shanghai Shen Lian Biomedical have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

Our examination of Shanghai Shen Lian Biomedical 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Shanghai Shen Lian Biomedical that you should be aware of.

If these risks are making you reconsider your opinion on Shanghai Shen Lian Biomedical, explore our interactive list of high quality stocks to get an idea of what else is out there.

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