Price-to-Sales (P/S)

What is P/S Ratio? What Does it Measure?

Price-to-sales ratio is a relative valuation metric that evaluates whether a company is undervalued or overvalued by the market. It is often used as an alternative for P/E ratio and P/B ratio.

Calculation

The calculation of the P/S ratio follows the formula below:

P/S Ratio = Per SharePrice ÷ Sales Per Share

As the calculation suggests, this metric measures the price which the market is willing to pay for each dollar of sales (also called revenue) the company has.

A high P/S ratio generally implies that the company is overvalued since it suggests that the price of the stock is much higher than its sales. On the other hand, a low P/S ratio implies the company is undervalued.

Drawbacks

Despite the usefulness of the P/S ratio, there are some downsides to this metric:

• Using sales (or revenue) to estimate a company might be inconclusive because it neglects the factors bring by earnings (for example, a company having negative earnings but high sales [revenue]). This explains why under most scenarios, investors would prefer P/E and P/B ratios rather than P/S due to the P/S ratio’s downside.

Application of the P/S Ratio

The P/S ratio is a relative valuation metric, therefore, investors should compare the P/S ratio between similar companies or companies in the same industry.

Since different industries’ sales vary due to their differences in their businesses, geographies, markets, etc. using the P/S ratio to compare these companies will give a biased result. This is the same for P/E and P/B ratios. Hence, it is essential to compare P/S ratios between similar companies.