Price To Sales Ratio

The Price to Sales Ratio (Price/Sales) is a stock valuation tool used to compare the market capitalization of a company to its sales.  Essentially, it reveals the market value assigned to each dollar of sales generated.  

The price to sales ratio provides as a strong alternative to looking at companies with no earnings; in this case, the price to earnings ratio is non-existent.  During the internet boom in the late 90's, analysts would use the price to sales ratio as an alternative means of valuation for many of the new startups which were bringing in high sales volumes but did not yet turn a net profit.

In general terms, a lower P/S ratio is considered to be a safer and more profitable opportunity than a company which has a high P/S ratio.  The idea is that the market has undervalued the companies sales.  However, like any other financial ratio, one needs to be careful with the application.  A low value might indicate troubles within the company; due dilligence should always be done on the financial condition of the company.

Calculate Price to sales

Price to Sales Ratio

Advantages of the Price to Sales Ratio

Advocates will suggest that one of the key advantages that the PSR provides lies in fact that it is less subject to accounting manipulation than P/E ratio which can be very misleading at times.  The PSR ratio also does a great job at valuing companies or industries which are cyclical in nature and vulnerable to the business cycle such as the construction or automotive industries.  Based on the economic condition, these companies will have large shifts in their earnings power, making their earnings figures less reliable.  During these periods, these stocks can become depressed in value and the price to sales ratio can help investors find bargains within the sector.

Disadvantages of the Price to Sales Ratio

The obvious flipside to this coin is that companies will eventually need to turn a profit.  All the sales in the world will mean nothing if the company cannot turn a net profit and generate value for their shareholders.  The price to sales ratio has a better use in environments that we discussed above.  Cyclical stocks or stocks that have just come to market and are relatively new provide for the most useful application of this ratio.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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