What Is the Price-To-Sales Ratio - P/S Ratio?
The price-to-sales ratio (P/S ratio) is a valuation ratio that compares a company’s stock price to its revenues. It's an indicator of the value placed on each dollar of a company’s sales or revenues. It 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 P/S Ratio Is
The P/S ratio is calculated as:
How to Calculate Price-To-Sales 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 Price-To-Sales Tell You?
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 twelve 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.
- Provides a way to value a company with little or no profits.
- A higher (lower) P/S ratio relative to peers or the industry may suggest a company is overvalued (undervalued).
- P/S ratio comparison of companies in different industries might not be useful given the differences in needed expenses to generate profits or pay debts.
Example of How to Use 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 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 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 vs. $455 million), which may be better than what's expected for its peers.
Taking that a step further, consider Apple (NASDAQ: AAPL)'s 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. And with its share price at $156.82, its P/S ratio is 2.8. Meanwhile, the likes of Google (NASDAQ: GOOGL) trades with a P/S ratio of 5.9 and Microsoft (NASDAQ: MSFT) at 7.2 – suggesting Apple might be undervalued.
The Difference Between P/S Ratio and EV-to-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. As well, comparing companies in different industries can prove difficult. 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. To learn more about how to use the P/S ratio, visit Investopedia’s article on how to use the P/S ratio to value stocks.