GuangYuYuan Chinese Herbal Medicine Co., Ltd.'s (SHSE:600771) Price Is Out Of Tune With Revenues

When you see that almost half of the companies in the Pharmaceuticals industry in China have price-to-sales ratios (or "P/S") below 3.1x, GuangYuYuan Chinese Herbal Medicine Co., Ltd. (SHSE:600771) looks to be giving off strong sell signals with its 7.7x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for GuangYuYuan Chinese Herbal Medicine

How Has GuangYuYuan Chinese Herbal Medicine Performed Recently?

For instance, GuangYuYuan Chinese Herbal Medicine's receding revenue in recent times would have to be some food for thought. 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.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on GuangYuYuan Chinese Herbal Medicine's 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 GuangYuYuan Chinese Herbal Medicine'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 3.0%. Regardless, revenue has managed to lift by a handy 15% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 18% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that GuangYuYuan Chinese Herbal Medicine 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of GuangYuYuan Chinese Herbal Medicine 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for GuangYuYuan Chinese Herbal Medicine that you should be aware of.

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).

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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.

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