Rhythm Pharmaceuticals, Inc.'s (NASDAQ:RYTM) Popularity With Investors Is Under Threat From Overpricing

You may think that with a price-to-sales (or "P/S") ratio of 31.2x Rhythm Pharmaceuticals, Inc. (NASDAQ:RYTM) is a stock to avoid completely, seeing as almost half of all the Biotechs companies in the United States have P/S ratios under 12.7x and even P/S lower than 4x aren't out of the ordinary. 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 Rhythm Pharmaceuticals

How Rhythm Pharmaceuticals Has Been Performing

Rhythm Pharmaceuticals certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on analyst estimates for the company? Then our free report on Rhythm Pharmaceuticals will help you uncover what's on the horizon.

Is There Enough Revenue Growth Forecasted For Rhythm Pharmaceuticals?

In order to justify its P/S ratio, Rhythm Pharmaceuticals would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an explosive gain to the company's top line. In spite of this unbelievable short-term growth, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

Shifting to the future, estimates from the nine analysts covering the company suggest revenue should grow by 102% each year over the next three years. Meanwhile, the rest of the industry is forecast to expand by 97% per annum, which is not materially different.

With this in consideration, we find it intriguing that Rhythm Pharmaceuticals' P/S is higher than its industry peers. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Rhythm Pharmaceuticals' P/S

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.

Analysts are forecasting Rhythm Pharmaceuticals' revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

It is also worth noting that we have found 2 warning signs for Rhythm Pharmaceuticals that you need to take into consideration.

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.