PRICE-TO-SALES RATIO (PSR)

DEFINITION:

Price-to-sale ratio is a valuation ratio that compares stock price of company to its revenues. It’s an indicator of the value placed on each dollar of sales or revenues of the company. It can be calculated either by dividing the market capitalization of the company by its total sales over a chosen period. It is usually twelve months, on a per-share basis by dividing the stock price by sales per share. The P/S ratio is called “sales multiple” or “revenue multiple.”

FORMULA:

Its formula is:

Price to Sales Ratio Formula

HOW TO CALCULATE PRICE-TO-SALE RATIO?

To determine the P/S ratio, you must divide the current stock price by the sales per share. The current stock price can be find by working the stock symbol into any major finance website. The sales per share metric is calculated as dividing a sales of company by the number of unpaid shares.

What Price-To-Sales Tells You?

The price-to-sales ratio is a analysis and valuation tool for stakeholders and experts. The ratio tells you that how much investors are ready to pay per dollar of sales. Like all other ratios, the P/S ratio is most important when used to compare corporations in the same sector. A low ratio price-to-sale may show the stock is underestimated. And a ratio that is considerably above the normal may tell you overvaluation.

Limitations of using Price-to-Sale Ratio:

The P/S ratio doesn’t tell us that company makes any earnings. And it will never tell us that company make any earnings. Comparing companies in different industries can cause various difficulties. Companies that make video games will have different abilities when it turns sales into profits, usually compared to the likes of grocery shops.

 P/S ratios do not take any action for debt loads or the status of balance sheet of a company. That is, a company with almost no debt will be more attractive than a company with the extreme levered company with the same P/S ratio.

Key Points:

  • It usually provides different ways to make importance of a company with little or with no profits.
  • A higher (lower) P/S ratio relative to upper class or the company may tell a company is overvalued or is undervalued.
  • P/S ratio differentiate companies in different industries, not be useful given the differences in needed expenses to make profits.

Example of how to use Price-to-Sale Ratio:

Consider the weekly sales for Acme Co. The sales for economic year 1 (FY1) are actual sales, while sales for FY2 are experts’ average forecasts. Acme has 100 million shares outstanding, with the shares presently interchange at $10.

Acme Co. Weekly Sales

At the present time, Acme’s P/S ratio on a trailing 12-month basis calculated as:

Sales for past 12 months that is (TTM) = $455 million (sum of all FY1 values)

    Sales per share, that is (TTM) = $4.55 ($455 million in sales / 100 million shares outstanding)

    Price to sale ratio = 2.2 ($10 share price / $4.55 sales per share)

So, this was all about price-to-sale ratio.

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