Hainan Haiyao Co., Ltd. (SZSE:000566) shares have continued their recent momentum with a 56% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 28%.

Following the firm bounce in price, you could be forgiven for thinking Hainan Haiyao is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.6x, considering almost half the companies in China's Pharmaceuticals industry have P/S ratios below 3.8x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Hainan Haiyao's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Hainan Haiyao 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Hainan Haiyao's Revenue Growth Trending?

In order to justify its P/S ratio, Hainan Haiyao would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a frustrating 34% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 49% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 217% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Hainan Haiyao is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From Hainan Haiyao's P/S?

The strong share price surge has lead to Hainan Haiyao's P/S soaring as well. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Hainan Haiyao 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Having said that, be aware Hainan Haiyao is showing 1 warning sign in our investment analysis, you should know about.

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).

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.