What Is the Price-to-Sales (P/S) Ratio?
The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value placed on each dollar of a company’s sales or revenues.
The P/S ratio can be calculated either by dividing the company’s market capitalization by its total sales over a designated period – usually twelve months, or on a per-share basis by dividing the stock price by sales per share. The P/S ratio is also known as a "sales multiple" or "revenue multiple."
The Formula for the Price-to-Sales (P/S) Ratio is:
P/S Ratio=Sales per ShareMarket Value per Share
How to Calculate the Price-to-Sales (P/S) Ratio
To determine the P/S ratio, one must divide the current stock price by the sales per share. The current stock price can be found by plugging the stock symbol into any major finance website. The sales per share metric is calculated as dividing a company’s sales by the number of outstanding shares.
What Does the Price-to-Sales (P/S) Ratio Reveal?
The price-to-sales ratio is a key analysis and valuation tool for investors and analysts. The ratio shows how much investors are willing to pay per dollar of sales. Like all ratios, the P/S ratio is most relevant when used to compare companies in the same sector. A low ratio may indicate the stock is undervalued, while a ratio that is significantly above the average may suggest overvaluation.
The typical 12-month period used for sales in the price-to-sales ratio is generally the past four quarters (also called trailing 12 months or TTM), or the most recent or current fiscal year. A price-to-sales ratio that is based on forecast sales for the current year is called a forward ratio.
- IRR is the rate of growth a project is expected to generate.
- IRR is calculated by the condition that the discount rate is set such that the NPV = 0 for a project.
- IRR is used in capital budgeting to decide which projects or investments to undertake and which to forgo.
Example of How to Use the Price-to-Sales (P/S) Ratio
As an example, consider the quarterly sales for Acme Co. shown in the table below. The sales for fiscal year 1 (FY1) are actual sales, while sales for FY2 are analysts’ average forecasts (assume that we are currently in Q1 of FY2). Acme has 100 million shares outstanding, with the shares presently trading at $10.
At the present time, Acme’s P/S ratio on a trailing-12-month basis would be calculated as follows:
- Sales for the past 12 months (TTM) = $455 million (sum of all FY1 values)
- Sales per share (TTM) = $4.55 ($455 million in sales / 100 million shares outstanding)
- P/S ratio = 2.2 ($10 share price / $4.55 sales per share)
Acme’s P/S ratio for the current fiscal year would be calculated as follows:
- Sales for the current fiscal year (FY2) = $520 million
- Sales per share = $5.20
- P/S ratio = $10 / $5.20 = 1.92
If Acme’s peers—which we assume are based in the same sector and are of similar size in terms of market capitalization—are trading at an average P/S ratio (TTM) of 1.5, compared with Acme’s 2.2, it suggests a premium valuation for the company. One reason for this could be the 14.2% revenue growth that Acme is expected to post in the current fiscal year ($520 million versus $455 million), which may be better than what is expected for its peers.
Taking that a step further, consider Apple's (NASDAQ: AAPL) fiscal 2018 revenues of $265.6 billion. With 4.73 billion in outstanding shares as of January 2019, Apple's sales per share is $56.15. With its share price at $156.82, its P/S ratio is 2.8. Meanwhile, Google (NASDAQ: GOOGL) trades with a P/S ratio of 5.9, and Microsoft (NASDAQ: MSFT) at 7.2, suggesting that Apple might be undervalued.
The Difference Between P/S Ratio and EV/Sales
The P/S ratio doesn’t take into account debt. However, the enterprise value-to-sales ratio (EV/Sales) does. The EV/Sales ratio uses enterprise value and not market capitalization like the P/S ratio. Enterprise value adds debt and preferred shares to the market cap and subtracts cash. The EV/Sales ratio is said to be superior, although it involves more steps and isn’t always as readily available.
Limitations of Using P/S Ratio
The P/S ratio doesn’t take into account whether the company makes any earnings or whether it will ever make earnings. Comparing companies in different industries can prove difficult as well. Companies that make video games will have different capabilities when it comes to turning sales into profits, compared to the likes of grocery retailers.
As well, P/S ratios do not account for debt loads or the status of a company’s balance sheet. That is, a company with virtually no debt will be more attractive than a highly levered company with the same P/S ratio.
Learn More About the P/S Ratio
P/S ratios can help an investor quickly filter investments opportunities. For related insight, read more about how to use the P/S ratio to value stocks.