What is Price to Sales Ratio (P/S Ratio)?
Price to sales ratio also known as the P/S ratio is a fundamental analysis tool to directly compare the stock price with the company’s revenue. P/S ratio can be calculated by dividing the current share price by the sales per share.
It is also known as ‘sales multiple’ or ‘revenue multiple’ of a share. P/S ratio is a way to understand the valuation of a business or company, as it helps the investors to know, how much they are paying with respect to the company’s revenue.
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Formula And Calculation of Price to Sales Ratio
Price to sales ratio can be calculated in two ways
- Price to Sales Ratio (P/S) = Market Value Per Share/Sales Per Share
- P/S Ratio = Market Capitalization/Total Revenue
You can find the market capitalization by multiplying total outstanding shares with the current share price. Sales per share can be calculated by dividing total revenue by total outstanding shares.
Revenue can be found in profit and loss statement and total share capital can be found in the balance sheet of the company.
Suppose a company has generated yearly revenue of $500 million, the total outstanding share is 50 million and the current market price of the share is $100. What will be its P/S ratio?
So here first we have to find out the sales per share,
Sales per share = $500 million/50 million = $10
Price to Sales Ratio = $100/$10 = 10
So the company’s P/S ratio is 10.
Importance of P/S Ratio
- Price to sales ratio or P/S ratio is an important tool for investors for the fundamental analysis of a company.
- P/S ratio helps to find out the value pick for the investor. Suppose there is a loss-making company and you want to find out if it’s worth investing or not, so in order to compare the P/E ratio will not work there as it does not make money. In this scenario, the P/S ratio comes in rescue as it directly compares with the revenue. Let’s assume there is a profitable company with a P/S ratio of 5 and the loss-making company has a P/S ratio of 8, if the loss-making company turns around their business, a shareholder can generate huge profits.
- P/S ratio also helps new businesses or startups with zero net profit to evaluate the valuation of their assets.
Limitation of P/S Ratio
- One of the biggest limitations of price to sales ratio is, it does not consider the net earnings of a company or whether the company will make money in the future.
- Other limitation includes P/S ratios do not consider the debt of the company or the company’s balance sheet as well.
Well, the Price to sales ratio is an important fundamental analysis tool but works well combines with other ratios like P/E ratio, ROE, P/B ratio, and more.