Price to Sales (P/S) Ratio

The Price to Sales (P/S) Ratio (also known as the 'sales multiple' or 'revenue multiple') is a Valuation Ratio that compares a company’s stock price to its sales. In simple terms, it answers the question: “For every dollar of a company's sales, how much are investors currently willing to pay?” It was popularized by the famous investor Ken Fisher, who found it to be a powerful predictor of long-term returns. The P/S ratio is particularly useful because sales figures are generally considered more reliable and less susceptible to accounting shenanigans than earnings. This makes it a go-to metric for analyzing companies that aren't yet profitable—such as fast-growing tech startups or companies in a temporary downturn—where the more common Price to Earnings (P/E) Ratio would be meaningless. A lower P/S ratio often suggests that a stock may be undervalued, while a higher one can indicate the opposite.

Calculating the P/S ratio is straightforward, but interpreting it requires a bit of context and finesse.

There are two common ways to calculate the P/S ratio:

1. Method 1 (Company-Level): P/S Ratio = Market Capitalization / Total Revenue
   • Market Capitalization is the total value of all of a company's shares (Share Price x Number of Shares).
   • Total Revenue is the company’s total sales over a specific period, typically the last Trailing Twelve Months (TTM).
2. Method 2 (Per-Share Level): P/S Ratio = Current Share Price / Sales per Share
   • Sales per Share is the total revenue divided by the number of shares.

Both formulas will give you the same result. The first is often quicker if you already have the market cap figure handy.

There is no universal “good” P/S ratio. A ratio of 1.0 means you are paying $1 for every $1 of the company's annual sales. A ratio below 1.0 is often considered attractive by Value Investing proponents, while a ratio above 2.0 might be seen as expensive. However, context is everything. Imagine two pizza shops. Shop A has a low P/S ratio because it's a high-volume, low-price neighborhood joint. Shop B, a gourmet pizzeria, has a much higher P/S ratio. You can't say Shop A is “better” without more information. To use the P/S ratio effectively, you should:

• Compare within the same industry: A software company with high Profit Margins will naturally command a higher P/S ratio than a low-margin grocery chain. Comparing the P/S of Microsoft to Kroger is like comparing apples to oranges.
• Compare against a company's own history: Is the company's current P/S ratio higher or lower than its five-year average? A significant drop might signal a buying opportunity, while a spike could be a warning sign.

Like any tool in an investor's toolkit, the P/S ratio has moments where it shines and moments where it can be misleading.

• Great for Unprofitable Companies: The P/S ratio is your best friend when looking at Growth Stocks or turnaround situations. Since every company has sales (or revenue), you can use it to value a business even when it has no earnings (profits), rendering the P/E ratio useless.
• More Stable and Reliable: Revenue is the “top line” on an income statement and is less subject to Creative Accounting than earnings. Profits can be influenced by depreciation rules, tax strategies, and other non-cash expenses, but sales are a more straightforward figure.
• Excellent for Cyclical Stocks: Industries like automakers, airlines, and construction have earnings that swing dramatically with the economic cycle. During a recession, their earnings can vanish, making their P/E ratios skyrocket or become negative. Sales, however, are far more stable, providing a more consistent valuation measure through good times and bad.

• It Ignores Profitability: This is the P/S ratio's biggest blind spot. A company can have billions in sales and still be a terrible investment if it never turns those sales into profit. A low P/S ratio might simply reflect a business with a terrible Net Profit Margin that loses money on every sale.
• It Overlooks Debt: The P/S ratio only looks at the equity value (market cap) and ignores a company's debt load. Two companies could have the same P/S ratio, but one might be debt-free while the other is drowning in liabilities. For a more complete picture, some investors prefer the Enterprise Value to Sales (EV/Sales) ratio, which includes debt in its calculation.
• Business Model Differences: As mentioned, different industries have vastly different profit structures. Using the P/S ratio to compare a bank to a retailer is a recipe for poor decisions.

For the value investor, the P/S ratio is less of a valuation tool and more of a discovery tool. While Benjamin Graham was wary of metrics that ignored profits, modern value investors use the P/S ratio to screen for stocks that the market might be unfairly punishing. A company with a historically low P/S ratio might be a “hidden gem” if its profitability is about to improve. For example, if a company with a P/S of 0.5 is undergoing a successful restructuring that is widening its profit margins, an investor who spotted this early could be handsomely rewarded. The P/S ratio helps you find these potential bargains that P/E-focused investors might completely overlook.

The P/S ratio is a powerful and essential metric, especially for finding opportunities in unconventional places. However, it should never be used in isolation. A low P/S ratio is not an automatic buy signal; it's an invitation to dig deeper. Always use it alongside other metrics to analyze a company's profitability, debt, and overall financial health. Think of it as a great first question in a long conversation with a company, not the final answer.