The price-to-sales ratio, also known as the price-sales ratio, PSR or P/S ratio, is a valuation multiple for stocks (inventory); an alternative method to price/book ratio and price/earnings ratio for valuing a stock. The ratio is sometimes referred to as a revenue multiple or sales multiple.
It is calculated by dividing a business’ share price by its sales revenue per share, or dividing the firm’s market capitalization by its revenue in the most recent year.
The P/S ratio gives us an idea of the value placed on each dollar of a business’ sales or revenues.
As is the case with all financial ratios, this metric is only meaningful when it is used to compare a company with others in the same industry.
By going over John Doe’s sales over the past 12 months, the price-to-sales ratio came in at 1.
Retail companies, for example, tend to have much higher P/S ratios than businesses highly involved in research and development.
The price-to-share ratio is one of the most useful ways to decide whether a share is cheap or expensive. It has been shown to be a good predictor of a share’s future performance.
A P/S ratio smaller than 1.0 is generally seen as a better investment, because the investor is paying less for each unit of sales. However, some unprofitable companies may also have a low P/S ratio.
A low ratio may be due to undervaluation, while an above-average one may suggest overvaluation.
Generally used for unprofitable enterprises
Because of this calculation’s limitation, P/S ratios are generally only used for unprofitable companies, because they do not have a price-earnings ratio.
The P/S ratio is also useful when comparing the valuation of start-up or very early-stage enterprise that have sales but are not yet profitable.
Analysts say price-to-sales ratios are useful because sales figures are used, which are relatively more reliable than other income statement items, such as earnings, which can be easily manipulated.
Video – The price-to-sales ratio explained