There's Reason For Concern Over Psychemedics Corporation's (NASDAQ:PMD) Massive 28% Price Jump

Despite an already strong run, Psychemedics Corporation (NASDAQ:PMD) shares have been powering on, with a gain of 28% in the last thirty days. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 27% in the last twelve months.

Although its price has surged higher, it's still not a stretch to say that Psychemedics' price-to-sales (or "P/S") ratio of 1x right now seems quite "middle-of-the-road" compared to the Healthcare industry in the United States, seeing as it matches the P/S ratio of the wider industry. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

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.

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 Psychemedics' earnings, revenue and cash flow.

How Is Psychemedics' Revenue Growth Trending?

The only time you'd be comfortable seeing a P/S like Psychemedics' is when the company's growth is tracking the industry closely.

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 12%. The last three years don't look nice either as the company has shrunk revenue by 7.8% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 8.0% 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 Psychemedics' 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

What We Can Learn From Psychemedics' P/S?

Its shares have lifted substantially and now Psychemedics' P/S is back within range of the industry median. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We find it unexpected that Psychemedics trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Psychemedics (at least 2 which make us uncomfortable), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Psychemedics, 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.