Royalty Pharma plc's (NASDAQ:RPRX) price-to-sales (or "P/S") ratio of 4.9x might make it look like a sell right now compared to the Pharmaceuticals industry in the United States, where around half of the companies have P/S ratios below 3x and even P/S below 0.9x are quite common. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Royalty Pharma's Recent Performance Look Like?

Royalty Pharma hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Royalty Pharma would need to produce impressive growth in excess of the industry.

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 2.5%. This has erased any of its gains during the last three years, with practically no change in revenue being achieved in total. Therefore, it's fair to say that revenue growth has been inconsistent recently for the company.

Looking ahead now, revenue is anticipated to climb by 7.3% per year during the coming three years according to the eight analysts following the company. That's shaping up to be materially lower than the 20% each year growth forecast for the broader industry.

With this in consideration, we believe it doesn't make sense that Royalty Pharma's P/S is outpacing its industry peers. 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 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 We Can Learn From Royalty Pharma'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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Royalty Pharma, this doesn't appear to be impacting the P/S in the slightest. 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with Royalty Pharma.

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.