price-to-sales_ratio [CapiPedia]

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======price-to-sales_ratio======
Price-to-Sales Ratio (also known as the 'P/S Ratio' or 'Sales Multiple'). This is a popular [[valuation ratio]] that tells you how much investors are willing to pay for every dollar of a company's sales. Think of it like this: if a company has a P/S ratio of 2, it means you're paying $2 for every $1 of its annual [[revenue]]. The calculation is straightforward: you take the company's total [[market capitalization]] and divide it by its total revenue over the past twelve months. Alternatively, you can divide the current [[share price]] by the [[revenue per share]]. The P/S ratio is a favorite tool when analyzing companies that aren't yet profitable, like many high-growth tech startups. Since they have no earnings, the famous [[price-to-earnings ratio|P/E ratio]] is useless, but they almost always have sales. The P/S ratio steps in to provide a valuable snapshot of how the market values the company's sales-generating ability, giving investors a handy metric when others don't apply.
===== How to Calculate the P/S Ratio =====
There are two simple ways to calculate this ratio, both giving you the same result.
  - **Formula 1:** P/S Ratio = [[Market Capitalization]] / [[Total Revenue]] (over the last 12 months)
  - **Formula 2:** P/S Ratio = [[Share Price]] / [[Revenue per Share]]
==== An Example in Action ====
Let's imagine a company, 'FutureTech Inc.', that is currently grabbing headlines.
  * It has a market capitalization of $500 million.
  * In the last twelve months, it generated $250 million in revenue.
Using Formula 1, its P/S Ratio would be:
  * $500 million / $250 million = 2
This means investors are currently valuing the company at two times its annual sales. Every dollar of FutureTech's sales is valued at $2 by the market.
===== Interpreting the P/S Ratio =====
A low P/S ratio is //generally// considered better, as it might indicate that a [[stock price|stock]] is [[undervalued]]. A high P/S ratio could suggest the stock is [[overvalued]], or that investors have very high expectations for future growth that are already baked into the price.
However, a "good" P/S ratio is never an absolute number; it's all about **context**. A P/S of 1 might be very cheap for a software company but expensive for a supermarket chain. To use it effectively, you must compare a company's P/S ratio to:
  * **Its own historical average:** Is the current P/S ratio higher or lower than its 5-year average? A significant deviation might be a red flag or a green light.
  * **Its direct competitors:** How does its P/S stack up against other companies //in the same industry//? This provides the most meaningful comparison.
===== When is the P/S Ratio Most Useful? =====
The P/S ratio shines in specific situations where other metrics fall short. It's particularly powerful for:
  * **Growth Companies:** For startups or tech firms in a high-growth phase, profits may be years away. Since they have no 'E' for the P/E ratio, the P/S ratio becomes a go-to metric to gauge valuation based on their sales traction.
  * **Cyclical Industries:** Think of automakers or construction firms. Their [[earnings per share|earnings]] can swing wildly with the economic cycle, making the P/E ratio volatile and unreliable. Sales, however, tend to be more stable, providing a clearer valuation picture.
  * **Turnaround Situations:** When a struggling company is restructuring, it might be incurring temporary losses. The P/S ratio helps investors look past the short-term negative earnings to value the underlying business's sales pipeline.
===== The Value Investor's Perspective =====
For [[value investing|value investors]], the P/S ratio is a fantastic hunting tool for uncovering hidden gems. Legendary investor [[Kenneth Fisher]], in his book //Super Stocks//, popularized its use, arguing that finding great companies at sensible prices was the key to extraordinary returns. He believed that, in the long run, sales growth and [[profit margins]] would drive a company's success, and a low P/S ratio offered a great entry point before the rest of the market caught on.
  * **Fisher's Rule of Thumb:** He generally avoided companies with P/S ratios above 1.5. For deep value opportunities, he hunted for companies with P/S ratios below 0.75.
  * **Finding a Margin of Safety:** A low P/S ratio can indicate that the market is overly pessimistic about a company's future profitability. If you believe the company can improve its margins over time, buying it at a low P/S multiple provides a significant [[margin of safety]]. The market is essentially paying you to wait for the business to improve.
===== Limitations of the P/S Ratio =====
While useful, the P/S ratio is not a silver bullet. You must be aware of its blind spots, as it can be misleading if used in isolation.
  * **It Ignores Profitability and Debt:** A company can have billions in sales but still be wildly unprofitable and drowning in [[debt]]. Sales are just the top line; they don't tell you if the company is actually making money or has a healthy [[cash flow]]. A low P/S ratio is meaningless if the company has no path to profitability.
  * **Industry Differences are Huge:** A software company with 80% margins and a grocery store with 2% margins will naturally have vastly different "normal" P/S ratios. Comparing them is like comparing apples and oranges. **Always** compare within the same industry.
  * **Sales Can Be Misleading:** Aggressive [[accounting]] practices can inflate sales figures, making a company look healthier than it is. Revenue recognition policies can differ, so it's always wise to dig into the financial statements.