Hunan Er-Kang Pharmaceutical Co., Ltd's (SZSE:300267) Popularity With Investors Under Threat As Stock Sinks 27%

Hunan Er-Kang Pharmaceutical Co., Ltd (SZSE:300267) shares have had a horrible month, losing 27% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 18% share price drop.

Even after such a large drop in price, given close to half the companies operating in China's Pharmaceuticals industry have price-to-sales ratios (or "P/S") below 3.4x, you may still consider Hunan Er-Kang Pharmaceutical as a stock to potentially avoid with its 4.5x 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 as high as it is.

See our latest analysis for Hunan Er-Kang Pharmaceutical

What Does Hunan Er-Kang Pharmaceutical's P/S Mean For Shareholders?

For example, consider that Hunan Er-Kang Pharmaceutical's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. 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 Hunan Er-Kang Pharmaceutical'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 outperform the industry for P/S ratios like Hunan Er-Kang Pharmaceutical's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 40% decrease to the company's top line. As a result, revenue from three years ago have also fallen 45% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 186% shows it's an unpleasant look.

With this in mind, we find it worrying that Hunan Er-Kang 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. 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 Hunan Er-Kang Pharmaceutical's P/S?

There's still some elevation in Hunan Er-Kang Pharmaceutical's P/S, even if the same can't be said for its share price recently. 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.

We've established that Hunan Er-Kang Pharmaceutical currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

Having said that, be aware Hunan Er-Kang Pharmaceutical is showing 1 warning sign in our investment analysis, you should know about.

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.