Halal Investment Series Part 18
The price-to-sales (P/S) ratio is a valuation ratio that compares the stock price of a company to its revenues. It represents the monetary value that financial markets have assigned to each dollar of a company’s sales or revenues.
For investors and analysts, the P/S ratio is an important analysis and valuation tool. The ratio indicates how much investors are willing to pay for each dollar of sales. You can calculate it on a per-share basis by dividing the stock price by sales per share or by dividing the company’s market capitalization by total sales over a specified period (usually twelve months). A sales multiple or revenue multiple is another name for the Price/Sales ratio.
The P/S ratio, like all ratios, is most useful when comparing companies in the same industry. An undervalued stock may have a low ratio. Whereas, an overvalued stock may have a high ratio.
Calculating the P/S Ratio
The most common 12-month period for sales in the P/S ratio is the previous four quarters (also known as the trailing 12 months or TTM), or the most recent or current fiscal year (FY). A forward P/S ratio is one that is calculated using forecast sales for the current year.
To calculate the Price/Sales ratio is by dividing the current stock price by the sales per share. By entering the stock symbol into any major finance website, you can find the current stock price. In addition, you can calculate sales per share by dividing a company’s revenue by the number of outstanding shares.
P/S Ratio=SPS/ MVS
Where:
MVS = Market Value per Share
SPS = Sales per Share
How It Works
The Price/Sales ratio does not consider whether or not the company earns money or will ever earn money. Comparing companies from various industries can also be difficult. Companies that make video games, for example, will have different capabilities when it comes to converting sales into profits than, say, grocery retailers. Furthermore, P/S ratios do not take into account debt loads or the state of a company’s balance sheet. In other words, a company with almost no debt will be more appealing than a highly leveraged company with the same P/S ratio.
The enterprise value-to-sales ratio (EV/Sales) takes debt into account, whereas the P/S ratio does not. The EV/Sales ratio, unlike the Price/Sales ratio, is based on enterprise value rather than market capitalization. Enterprise value is calculated by adding debt and preferred stock to the market capitalization and subtracting cash. The EV/Sales ratio is said to be superior, despite the fact that it requires more steps and is not always as readily available.