EyePoint Pharmaceuticals, Inc.'s (NASDAQ:EYPT) price-to-sales (or "P/S") ratio of 24.9x might make it look like a strong sell right now compared to the Pharmaceuticals industry in the United States, where around half of the companies have P/S ratios below 3.1x and even P/S below 0.7x are quite common. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for EyePoint Pharmaceuticals

How EyePoint Pharmaceuticals Has Been Performing

Recent times haven't been great for EyePoint Pharmaceuticals as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as EyePoint Pharmaceuticals' is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Still, the latest three year period was better as it's delivered a decent 18% overall rise in revenue. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

Turning to the outlook, the next three years should bring diminished returns, with revenue decreasing 2.6% each year as estimated by the nine analysts watching the company. Meanwhile, the broader industry is forecast to expand by 54% each year, which paints a poor picture.

In light of this, it's alarming that EyePoint Pharmaceuticals' P/S sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the negative growth outlook.

The Final Word

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.

We've established that EyePoint Pharmaceuticals currently trades on a much higher than expected P/S for a company whose revenues are forecast to decline. Right now we aren't comfortable with the high P/S as the predicted future revenue decline likely to impact the positive sentiment that's propping up the P/S. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider and we've discovered 4 warning signs for EyePoint Pharmaceuticals (1 is a bit concerning!) that you should be aware of before investing here.

If you're unsure about the strength of EyePoint Pharmaceuticals' 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.