Price to Sale Ratio (Price/Sales)
Price to sale ratio also known as P/S ratio or price/sales. By comparing the stock price of the company with total revenue, this ratio measure the value of the investor put on the for each dollar of revenue generated by the company or firm.
Definition: What is the P/S ratio?
Investors used the PS ratio mostly because it is easy to understand and basic valuation ratio. This ratio is used to find the valuation of the company based on the actual operation of the company without impacting for accounting adjustment. For those companies which are in the initial position or have net income zero or negative, this ratio is useful.
Generally, the low ratio is better because it indicates the undervaluation of the company. Just like another valuation ratio, price to sale ratio needs to look at from investors point of view as well as from historical way.
Price to sale ratio formula can be calculated by dividing the price of stock or marketing cap by sales per share or total company’s share.
Price to sale = Market cap/Total sales
From the income statement, investors can get the value of income statement. If in the numerator price of stock use then denominator will be sales per share. If in the numerator market cap use then the denominator is total sales.
Information of hypothetical company A of share price and sales per share in the below table. PS ratio presented in the below table also. Share price increased by 50 percent for 3 years whereas the sales growth pace is low. So in the 3 years, price/sales become more costly.
Analysis and interpretation
This ratio used by the industry for valuation. For the comparison of different companies across the industry P/S ratio used. Also, for the comparison of the company with its own history analyst use PS ratio.
For the companies which start initially can use this ratio because for new it gives the accurate calculation. Valuation of the business depends on the cycle of the business. In macro upswing, investors might prefer the cyclical companies. ‘Across the cycle average’ or ‘mid-cycle’ for the understanding of PS multiple is used by the cyclical companies.
Future expectations for all the valuation metrics are important. Analyzing of forecast revenue of minimum 3 years, future growth driving, and business model, for the analyst is necessary.