What Kunming Longjin Pharmaceutical Co., Ltd.'s (SZSE:002750) 38% Share Price Gain Is Not Telling You

Kunming Longjin Pharmaceutical Co., Ltd. (SZSE:002750) shareholders are no doubt pleased to see that the share price has bounced 38% in the last month, although it is still struggling to make up recently lost ground. But the last month did very little to improve the 78% share price decline over the last year.

Since its price has surged higher, you could be forgiven for thinking Kunming Longjin Pharmaceutical is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 9.9x, considering almost half the companies in China's Pharmaceuticals industry have P/S ratios below 3.1x. 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 Kunming Longjin Pharmaceutical

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

As an illustration, revenue has deteriorated at Kunming Longjin Pharmaceutical 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.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Kunming Longjin Pharmaceutical will help you shine a light on its historical performance.

Is There Enough Revenue Growth Forecasted For Kunming Longjin Pharmaceutical?

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

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 5.7%. As a result, revenue from three years ago have also fallen 78% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 17% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Kunming Longjin Pharmaceutical's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Does Kunming Longjin Pharmaceutical's P/S Mean For Investors?

The strong share price surge has lead to Kunming Longjin Pharmaceutical's P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Kunming Longjin Pharmaceutical 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. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Kunming Longjin Pharmaceutical that you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.