Hainan Haiyao Co., Ltd.'s (SZSE:000566) 27% Share Price Plunge Could Signal Some Risk

Hainan Haiyao Co., Ltd. (SZSE:000566) shares have retraced a considerable 27% in the last month, reversing a fair amount of their solid recent performance. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

Even after such a large drop in price, given around half the companies in China's Pharmaceuticals industry have price-to-sales ratios (or "P/S") below 3.4x, you may still consider Hainan Haiyao as a stock to avoid entirely with its 5.5x P/S ratio. 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.

Check out our latest analysis for Hainan Haiyao

How Has Hainan Haiyao Performed Recently?

As an illustration, revenue has deteriorated at Hainan Haiyao over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Hainan Haiyao's earnings, revenue and cash flow.

How Is Hainan Haiyao's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 34% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 49% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 182% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Hainan Haiyao's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

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

Hainan Haiyao's shares may have suffered, but its P/S remains high. 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.

We've established that Hainan Haiyao currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It is also worth noting that we have found 1 warning sign for Hainan Haiyao that you need to take into consideration.

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

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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.