What Is the Price-to-Sales (P/S) Ratio?
Let me explain the price-to-sales (P/S) ratio directly: it's a tool you can use to evaluate a stock's value by looking at the relationship between the company's stock price and its revenue. You calculate it to spot undervalued stocks and make better investment choices, especially when comparing companies in the same sector. I'll cover how to analyze it, the formula, and how it stacks up against something like the enterprise value-to-sales ratio for a thorough financial review.
Key Takeaways
The P/S ratio lets you compare a company's stock price to its sales, giving you insight into how the market values each dollar of revenue. If you see a lower P/S ratio, it might mean the stock is undervalued compared to similar companies in the sector, but a higher one could point to overvaluation. Remember, this ratio doesn't factor in earnings or debt, so don't rely on it alone—pair it with other metrics for a complete analysis. The enterprise value-to-sales (EV/Sales) ratio is a step up because it includes debt and preferred shares, though it's a bit more involved to figure out.
Analyzing the Price-to-Sales (P/S) Ratio: A Guide
You should know that the P/S ratio is an essential tool for analysis and valuation if you're an investor or analyst. It tells you how much investors are paying for each dollar of sales—divide the market cap by total sales over the last twelve months, or the stock price by sales per share. We also call it a sales multiple or revenue multiple.
Always compare it across companies in the same sector for relevance. A low ratio suggests the stock could be undervalued, and one much higher than average might mean it's overvalued. Typically, you use trailing twelve-month sales or the last fiscal year, but for projections, it's a forward P/S ratio.
To get the ratio, divide the current stock price by sales per share. Find the stock price on any finance site, and calculate sales per share by dividing total sales by outstanding shares. The formula is P/S Ratio = Market Value per Share / Sales per Share.
Keep in mind, this ratio doesn't look at earnings potential. It's tricky to compare across industries because profit conversion varies—like video games versus groceries. It also ignores debt and balance sheets, so a debt-free company looks the same as a leveraged one with identical P/S. That's where EV/Sales comes in— it uses enterprise value, adding debt and preferred shares while subtracting cash, making it more accurate but requiring extra steps.
Applying the P/S Ratio: Real-World Examples
Take Acme Co. as an example: their quarterly sales for fiscal year 1 are actual, and year 2 are forecasts. With 100 million shares at $10 each, trailing twelve-month sales are $455 million, so sales per share is $4.55, giving a P/S of 2.2. For the current year, projected sales are $520 million, sales per share $5.20, P/S 1.92. If peers average 1.5, Acme seems valued higher, possibly due to expected 14.3% growth.
Now look at Apple: 2020 revenues $274.5 billion, 16.53 billion shares, sales per share $16.60, stock at $145, P/S 8.73. Compared to Google's 6.29 and Microsoft's 10.87, Apple and Google might be undervalued, or Microsoft overvalued.
FAQs
You might wonder about the benefits of the P/S ratio for investors. It's a solid tool showing what investors pay per dollar of sales, calculated by market cap over sales or per share. Use it for same-sector comparisons—a low one hints at undervaluation, high at overvaluation.
As for limitations, it skips earnings entirely and struggles with cross-industry comparisons due to varying profit margins. It also ignores debt and balance sheets.
Then there's the EV/Sales ratio: it measures cost to buy a company's value based on sales, using enterprise value instead of market cap, adding debt and subtracting cash for a better undervaluation check—lower means more attractive.
The Bottom Line
In summary, the P/S ratio is a straightforward metric to gauge a company's valuation against its revenue, helping you compare stocks in the same sector for undervaluations. It has limits on debt and earnings, so consider EV/Sales for depth. These can guide your decisions, whether you're new or experienced.
Other articles for you
Tax-deferred investments allow earnings to grow without immediate taxation until withdrawal, offering potential benefits for retirement savings.
Murabaha is an Islamic financing method that uses cost-plus pricing instead of interest to comply with Sharia law.
Glocalization is the strategy of adapting global products and services to fit local markets, cultures, and regulations while maintaining a worldwide presence.
Nash equilibrium is a game theory concept where no player gains by changing their strategy if others keep theirs unchanged.
This text provides an overview of fund trading, including basics, types of funds, FAQs, key terms, and related articles on investment strategies and market indexes.
Capital gains are profits from selling assets at a higher price than purchased, subject to specific tax rules and rates.
A stock screener is a tool that helps investors filter stocks and ETFs based on custom criteria to identify trading or investment opportunities.
Accumulated depreciation tracks the total value reduction of assets over time on a company's balance sheet.
Customers are essential buyers of goods and services that drive business success through revenue and loyalty.
A high close is a manipulative trading tactic where small trades at high prices are made in the final minutes to inflate a stock's closing price.