DEFINITION of price to sale ratio P/S
The Price to Sales ratio P/S is a financial ratio used among investors to determine the value of a company.
WHAT IT IS IN ESSENCE
It is the price of a stock divided by sales-per-share of the company in the most recent fiscal year.
It is similar to the P/E ratio. The P/S ratio gives investors an idea on how much they’re paying for a dollar of sales. Instead of a dollar of earnings.
Essentially, the P/S number reveals the value placed on sales by the market.
The price to sales ratio can be a useful tool to use. Especially if you’re examining start-ups, small-cap companies. Or unprofitable companies with no earnings.
If there are no earnings, you can’t calculate a P/E, but as long as a company has sales or revenues, you can calculate a P/S.
The P/S ratio is often regarded by some stock market analysts as a better indicator of the growth potential of a company than the P/E ratio.
This is because sales revenue is more difficult to manipulate by accounting tricks than earnings.
HOW TO USE
The formula to calculate the P/S ratio is:
P/S Ratio = Price Per Share / Annual Net Sales Per Share
Price-to-sales ratio is a relative valuation measure. That’s because it’s only useful when it’s compared to the P/S ratio of other firms.
It varies dramatically by industry.
For example, retail companies typically display a much higher P/S ratio than companies highly involved in research and development.
Therefore, when comparing make sure the firms are within the same industry.
It is useful because they can give relevant data. Other income statement items, like earnings, can be the subject of manipulation by using different accounting rules.
Even though sales are difficult to manipulate, it’s not impossible.
P/S is appropriate to use when valuing most types of stock.
But note that it should never be the one metric to valuing a company.
For example, a business may have higher sales but a lower profit margin than a competitor, indicating that it’s not operating efficiently.