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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
Price to sales equals a company's share price divided by its per-share sales or revenue.
The price to sales ratio (also known as price to sales, price/sales, P/S or PSR) is a valuation metric that looks at a company's current share price relative to its sales or revenue per share. It is usually calculated by dividing the company's share price by its per-share sales or revenue, although it can also be calculated by dividing the company's market capitalization by its total sales or revenue in the past 12 months. A company trading at low price to sales, especially when compared to other companies in the same industry, is considered to be undervalued relative to its share price.
In general, a company trading at price to sales of less than 1.0 is worthy of note. As an illustration, consider a company that has $1.0 billion in sales, a market capitalization of $900 million and, therefore, a price to sales ratio of 0.9. This means that you can buy $1.0 of the company's sales for just $0.9. While this could point to an overlooked bargain, the low share price could also mean that there's something else wrong with this company.
P/S Ratio = Share Price = Market Capitalization = P/E Ratio x Profit Margin
Per-Share Sales Total Sales
Key Considerations
In the price to sales ratio, the numerator (share price) takes into account a company's leverage, whereas the denominator (per-share sales or revenue) does not. As a result, when comparing price to sales for two companies, the implicit assumption is that both firms have the same capital structure, which often isn't the case. For example, while it's easy to find lots of companies with no profits and huge debt trading at price to sales of 0.3 or less, most of them are probably on the verge of bankruptcy and definitely not bargain stocks.
This assumption becomes more problematic when comparing companies that operate in different industries since capital structures and profit margins vary widely from one industry to another. For example, grocery stores tend to have lower profit margins and earn only a few pennies on every dollar of sales as compared to medical device manufacturers. In other words, relative to the grocer, a medical device maker does not require as much in sales to make a $1.0 in earnings. According to Morningstar, grocers and medical device manufacturers have average price to sales ratios of 0.5 and 5.0 respectively. Hence, a grocer with a price to sales ratio of 2.0 should be viewed as expensive, while a medical device maker with the same price to sales ratio could be a bargain.
In view of the above, price to sales is most useful when comparing companies in the same sector or sub-sector.
P/E vs. P/S
Compared to the P/E ratio, the P/S ratio has the following advantages:
- Less Volatile: Sales are less volatile than earnings and the P/E ratio cannot be used to evaluate a company that is losing money. In other words, a company with negative earnings, but strong sales, may still be a good long-term investment and will always have a well-defined P/S ratio, but no P/E ratio.
- Harder to Manipulate: Sales are also harder to manipulate and subject to fewer accounting estimates and one-off events than earnings.
Nonetheless, sales mean very little without earnings. If two companies have the same price to sales ratio, but one has a higher profit margin (i.e. it's earning more money from sales), it is a better investment, all else being equal.
Price to Sales on Wikinvest
Wikinvest calculates Price to Sales as market capitalization divided by trailing twelve month (TTM) revenue. Our number would disagree with that on Yahoo! Finance because Yahoo! uses market capitalization from the day before. Wikinvest, on the other hand, calculates the number in real-time i.e. the number changes during the day as a company's market cap changes.
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