Price to sales (P/S) ratios between 1 and 2 are generally considered good, and ratios less than 1 are considered excellent. As with all equity valuation metrics, average P/S ratios can vary significantly between industries. It is important to view a company's P/S ratio in comparison to similar companies within the same industry.
The Price to Sales Ratio
The P/S ratio is an investment valuation ratio that shows a company's market capitalization divided by the company's sales for the previous 12 months. It is a measure of the value investors are receiving from a company's stock by indicating how much are they are paying for the stock per dollar of the company's sales. Analysts prefer to see a lower number for the ratio. A ratio of less than 1 indicates that investors are paying less than $1 per $1 of the company's sales. Any number higher than 4 is commonly considered unfavorable.
When to Use the Price to Sales Ratio
The P/S ratio is considered a particularly good metric for evaluating young, potential high-growth companies or companies in cyclical industries that may not show an actual net profit every year. The P/S ratio provides a financial evaluation measure that can provide a good basis for analyzing such companies that may be showing temporary negative earnings. It provides an alternative to evaluation metrics such as the price-earnings (P/E) ratio or dividend yield, metrics more properly applied to companies with net profitability. This is not to say that the P/S ratio is not useful in analyzing currently profitable companies. It is a particularly helpful metric for examining companies that are not showing profitability at the moment or that are showing only minimal profits.
Complement the P/S ratio by looking at profit margin metrics, such as operating profit margin. This ratio is considered a better evaluation tool when coupled with an examination of a company's debt situation. For this reason, the enterprise value to sales ratio, which factors debt into the equation, is a popular alternative to the P/S ratio.