Kangmei Pharmaceutical Co., Ltd.'s (SHSE:600518) price-to-sales (or "P/S") ratio of 5.5x may not look like an appealing investment opportunity when you consider close to half the companies in the Pharmaceuticals industry in China have P/S ratios below 3.6x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Kangmei Pharmaceutical Has Been Performing

Kangmei Pharmaceutical has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Kangmei Pharmaceutical's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as high as Kangmei Pharmaceutical's is when the company's growth is on track to outshine the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 12%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 7.5% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 18% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Kangmei Pharmaceutical is trading at a P/S higher than the industry. 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. There's a very 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 Bottom Line On Kangmei Pharmaceutical's P/S

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.

Our examination of Kangmei Pharmaceutical revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Kangmei Pharmaceutical, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.