Subdued Growth No Barrier To Kangmei Pharmaceutical Co., Ltd. (SHSE:600518) With Shares Advancing 35%

The Kangmei Pharmaceutical Co., Ltd. (SHSE:600518) share price has done very well over the last month, posting an excellent gain of 35%. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

After such a large jump in price, you could be forgiven for thinking Kangmei Pharmaceutical is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.8x, 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.

See our latest analysis for Kangmei Pharmaceutical

What Does Kangmei Pharmaceutical's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Kangmei Pharmaceutical, which is generally not a bad outcome. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Although there are no analyst estimates available for Kangmei Pharmaceutical, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 4.4% last year. Revenue has also lifted 15% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 216% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Kangmei Pharmaceutical's P/S exceeds that of its industry peers. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Bottom Line On Kangmei Pharmaceutical's P/S

The strong share price surge has lead to Kangmei Pharmaceutical's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Kangmei Pharmaceutical revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for Kangmei Pharmaceutical that we have uncovered.

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.