Price To Sales Ratio

Rounding out the fundamental analysis series, we are now going to look at the Price to Sales Ratio, what it is, and how it might be helpful in evaluating an investment.

What is the Price to Sales Ratio?

The Price to Sales Ratio (P/S Ratio) may also be referenced as a sales multiple or revenue multiple.

Similar to the Price to Book (P/B) Ratio, it compares the market price of a company to another fiscal number, in this case, sales, to help investors when comparing companies, they may want as an investment.

sales ratio formula

Again like the P/B Ratio, you can take the market capitalization of a company (its share price times the number of outstanding shares) and divide by overall sales.

Alternatively, you could take the market share price and divide it by sales per share.

In this case, sales would be over a specific timeframe, usually one year or 12 months.

Generally, one would use the past four quarters, also referred to as the trailing 12 months (TTM), but may also use the most recent or current fiscal year (FY).

For example, if Company XYZ had a share price of $20 and it had 1 million shares outstanding, its market capitalization would be $20 Million.

If XYZ had TTM sales of $5 Million, its Price to Sales Ratio would be 4.

We would get the same answer if we took XYZ’s share price of $20 and divided it by the sales per share.

$5 Million in TTM sales divided by 1 Million outstanding shares = $5 of sales per share.  $20 / $5 = 4.

Putting the P/S Ratio to Use

Numbers don’t live in a vacuum, and one number doesn’t necessarily tell you much.

However, if you know what the average P/S Ratio is for a given industry, you could compare a company’s P/S Ratio to the average to determine whether it may be overvalued or undervalued.

You may see that one company has a premium added to its P/S Ratio when compared to other peers in its sector, and take that information to do a deeper dive to determine why that might be.

Is that company expected to have larger growth than its peers, thereby justifying the premium, or is something else causing it to be otherwise overvalued?

1 2 3
View single page >> |

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

How did you like this article? Let us know so we can better customize your reading experience.


Leave a comment to automatically be entered into our contest to win a free Echo Show.