Rhythm Pharmaceuticals, Inc.'s (NASDAQ:RYTM) price-to-sales (or "P/S") ratio of 29.8x might make it look like a strong sell right now compared to the Biotechs industry in the United States, where around half of the companies have P/S ratios below 12x and even P/S below 4x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Rhythm Pharmaceuticals' Recent Performance Look Like?

Recent times have been advantageous for Rhythm Pharmaceuticals as its revenues have been rising faster than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

Rhythm Pharmaceuticals' P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered an exceptional 133% gain to the company's top line. This great performance means it was also able to deliver immense revenue growth over the last three years. Accordingly, shareholders would have been over the moon with those medium-term rates of revenue growth.

Shifting to the future, estimates from the ten analysts covering the company suggest revenue should grow by 70% per annum over the next three years. Meanwhile, the rest of the industry is forecast to expand by 148% per annum, which is noticeably more attractive.

With this information, we find it concerning that Rhythm Pharmaceuticals is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What Does Rhythm Pharmaceuticals' P/S Mean For Investors?

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.

We've concluded that Rhythm Pharmaceuticals currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

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

If you're unsure about the strength of Rhythm 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.