Psychemedics Corporation's (NASDAQ:PMD) Shares Climb 37% But Its Business Is Yet to Catch Up

The Psychemedics Corporation (NASDAQ:PMD) share price has done very well over the last month, posting an excellent gain of 37%. Notwithstanding the latest gain, the annual share price return of 9.9% isn't as impressive.

In spite of the firm bounce in price, it's still not a stretch to say that Psychemedics' price-to-sales (or "P/S") ratio of 0.9x right now seems quite "middle-of-the-road" compared to the Healthcare industry in the United States, where the median P/S ratio is around 1.1x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Check out our latest analysis for Psychemedics

What Does Psychemedics' P/S Mean For Shareholders?

For example, consider that Psychemedics' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

Although there are no analyst estimates available for Psychemedics, 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 P/S?

In order to justify its P/S ratio, Psychemedics would need to produce growth that's similar to the industry.

Retrospectively, the last year delivered a frustrating 11% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 15% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 8.2% shows it's an unpleasant look.

With this information, we find it concerning that Psychemedics is trading at a fairly similar P/S compared to the industry. 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 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.

The Final Word

Psychemedics' stock has a lot of momentum behind it lately, which has brought its P/S level with the rest of the industry. 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.

The fact that Psychemedics currently trades at a P/S on par with the rest of the industry is surprising to us since its recent revenues have been in decline over the medium-term, all while the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Psychemedics (1 makes us a bit uncomfortable!) that you need to be mindful of.

If you're unsure about the strength of Psychemedics' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.