The Price-to-sales ratio is one of the most important valuations and analysis metrics for investors and analysts. The ratio presents how much investors want to pay per dollar of sales. The price-to-sales ratio (P/S) is determined by dividing a company’s market capitalization (the number of outstanding shares multiplied by the share price) by its cumulative revenue (sales) over the previous 12 months or by dividing per-share stock price by sales per share.
In general, the lower the price-to-sales ratio, the more appealing the purchase. Investors often use the P/S ratio, a sales multiple, or a revenue multiple words interchangeably. The P/S ratio is the most relevant ratio when comparing companies within the same sector. It also helps to compare the price to sales ratio of the stock over the past years.
Here is the simplified example:
|Sales Per Share||$5||$6||$7||$11|
|P/S Ratio (Share Price/Sales Per Share)||2||2.2||2.6||2.5|
This table shows the share price and the sales per share for a specific company. We can calculate the price-to-sales ratio by dividing the per-share stock price by sales per share. The company’s share price rose 1.5 times higher over the four years, while the sales per share increased slower. Thus, the investors are paying more for the shares if we compare it to four years ago data.
From the table above, we can see that in 2000, people paid $2 per share, and in 2003, they paid $2.50 for the same share. There can be several different factors such as trends, investor speculation that can cause an increase in the P/S ratio.
Here is another example; Considering the stock of XYZ company. The Xyz company has 200 million shares outstanding with the current price per share of $15. The sales for the past 12 months (TTM) are $500 million. The calculation of price to sales ratio will be:
- Sales per share (TTM)= $500 million of sales/ 200 million shares outstanding = $2.50
- P/S ratio = $15 stock price/ $2.50 sales per share = 6
Of course, the P/S ratio must be used with other financial ratios to determine if a stock is valued properly. If the P/S ratio of a specific company is lower than other companies in the same industry that is profitable, investors may decide to buy the stock due to its low valuation. Let’s take a look further by comparing Google, Microsoft, and Apple stock. The three stocks operate in the same industry. Here are the data of each company’s P/S ratio:
From this data, we can compare the P/S ratio of three companies from the same industry. A significantly low ratio may indicate that the stock is undervalued, while a high ratio may be overvalued. The sample data may indicate that Google and Apple are undervalued, or Microsoft may be overvalued.
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