Kontafarma China Holdings Limited (HKG:1312) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 11% is also fairly reasonable.

Even after such a large jump in price, it would still be understandable if you think Kontafarma China Holdings is a stock with good investment prospects with a price-to-sales ratios (or "P/S") of 0.3x, considering almost half the companies in Hong Kong's Pharmaceuticals industry have P/S ratios above 1.5x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

What Does Kontafarma China Holdings' P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Kontafarma China Holdings over the last year, which is not ideal at all. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Is There Any Revenue Growth Forecasted For Kontafarma China Holdings?

The only time you'd be truly comfortable seeing a P/S as low as Kontafarma China Holdings' is when the company's growth is on track to lag the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 4.2%. This means it has also seen a slide in revenue over the longer-term as revenue is down 11% 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.

Comparing that to the industry, which is predicted to deliver 9.5% 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 understandable that Kontafarma China Holdings' P/S would sit below the majority of other companies. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Bottom Line On Kontafarma China Holdings' P/S

Kontafarma China Holdings' stock price has surged recently, but its but its P/S still remains modest. 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.

As we suspected, our examination of Kontafarma China Holdings revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

You need to take note of risks, for example - Kontafarma China Holdings has 2 warning signs (and 1 which is significant) we think you should know about.

If you're unsure about the strength of Kontafarma China Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.