What is the Price-to-Sales (P/S) Ratio?

The price-to-sales ratio (P/S ratio) is like a club in a golf bag…

When you go golfing, you can typically choose from 14 golf clubs in a standard set. Depending on the situation, you may select a wedge, putter, driver, or wedge. Likewise, the P/S ratio is one of the financial metrics available in your bag of company valuation tools.

The price-to-sales ratio (P/S ratio) is a financial metric for the valuation of a company. The P/S ratio’s formula is the price per share divided by sales per share. The P/S ratio is also referred to as the “sales multiple” because the ratio shows the market value that investors place on company sales.

The P/S ratio is a useful valuation ratio because it allows you to estimate the value of companies that don’t have a positive net income. Other valuation ratios (like the price-to-earnings ratio (P/E ratio) or the price-to-cash-flow ratio (P/CF ratio)) use an adjusted revenue number. The P/S ratio focuses on company sales (revenue), which is the top line item on a company’s income statement and is often less subject to manipulation. Unlike earnings or net income, revenue can’t be negative.

P/S ratios use price per share and sales per share (revenue divided by outstanding shares) so that you can make an accurate comparison of companies.

The P/S ratio is the division of the stock price by sales per share.

You can find the stock price of a publicly-traded company for free online in many places, including Google Finance, Yahoo Finance, and the Wall Street Journal.

Sales per share is revenue divided by the number of shares outstanding. Typically, financial analysts use a company’s revenue over an entire fiscal year or trailing 12 months (referred to as TTM).

You can find the revenue and number of shares outstanding of a publicly-traded company on its 10-k — an annual filing with the Securities and Exchange Commission (SEC). The 10-k is available on a company’s investor relations website and the SEC’s EDGAR online database. The revenue is the top item on a company’s income statement, and the outstanding shares are listed at the beginning of the 10-k document.

Let’s calculate the P/S ratio of Starbucks for its fiscal year that ended Sep. 29, 2019.

Since Sep. 29, 2019 was a Sunday; let’s use Starbucks’ share price from Monday, Sep. 30, 2019: $88.42 according to Yahoo Finance.

The 10-k from Starbucks indicates that the company had 1.18B shares of stock outstanding and $26.51B in revenue.

The P/S ratio of Starbucks was 3.93 ($88.42/($26.51B/1.18B)).

The price-to-sales ratio (P/S ratio) tells you how much investors are willing to pay on a company’s ability to generate revenue.

The P/S ratio is also referred to as the sales multiple or revenue multiple because it summarizes in a single number the market price measured against revenue.

When using historical numbers, a P/S ratio provides a valuation metric on past company performance. Alternatively, a P/S ratio using forecasted revenue is a forward-looking metric that seeks to place a value on future company sales.

When using the price-to-sales ratio (P/S ratio), you need to put the ratio into context by tracking its changes over time (e.g., over four quarters or over three years) or comparing it against the P/S ratios of comparable companies in the same sector or an industry average.

Here are some examples of how the P/S ratio is used to value stocks:

• An increasing trend in the P/S ratio suggests that investors are putting a premium on company revenues.
• A decreasing trend in the P/S ratio suggests that investors are putting a discount on company revenues.
• When comparing the P/S ratios of companies in the same sector, you may find that a company is overvalued or undervalued in relation to its peers.

The average price-to-sales ratio (P/S ratio) of the S&P 500 is 1.55 for the period from January 2001 to June 2020. During this period, the P/S ratio has ranged between a bottom of 0.80 in March 2009 and a peak of 2.28 in December 2019.

On June 10, 2020, the P/S ratio of the S&P 500 stood at 2.26.

Let’s take a look at an example of some price-to-sales ratios (P/S ratios) for industries included in the S&P 500 index for the first quarter of 2020:

The P/S ratio varies greatly per industry and will change quarterly.

In general, a good price-to-sales ratio (P/S ratio) is one above the P/S ratio of the S&P 500. A company with a P/S ratio higher than that of the S&P 500 is able to show that investors are willing to pay a higher premium for the company’s revenues than for the revenues of the stock market as a whole.

However, P/S ratios vary per industry and should be put into context with additional analysis. You should track the performance of a company’s P/S ratio over time, and compare the ratio against those from peers in the same sector. Performance over time and relation to peers are two useful practices to determine whether a P/S ratio is good or bad.

The main difference between the price-to-sales ratio (P/S) ratio and the price-to-book-value ratio (P/B ratio) is that the P/B ratio measures stock price against the net assets (total assets minus total liabilities).

The P/B ratio is a valuation ratio that summarizes in a single number the value that investors place on the assets wholly owned by the company.

Rules of thumb for the P/B ratio are: P/B ratio > 1: Investors pay a premium for the company’s net assets because they believe that the company is worth more than its reported assets. P/B ratio = 1: Investors believe the market value matches the reported book value. P/B ratio < 1: Investors put a discount on the company’s net assets because they believe that the company is worth less than its reported assets.

The enterprise value-to-sales ratio (EV/sales ratio) is a valuation ratio that divides enterprise value (Market capitalization + Total Debts – Cash) by company sales.

Unlike the price-to-sales ratio, the EV/sales ratio considers company debt when quantifying the value that investors place on company revenue. Companies can secure capital for financing projects and investments by exchanging equity for company ownership or taking out debt. The EV/sales ratio is a valuation ratio that considers capital from debt and equity sources, while the P/S ratio only considers capital from equity sources.

The principal limitation of the price-to-sales ratio (P/S ratio) as a valuation ratio is that it fails to account for capital that may come from debt sources. The P/S ratio only accounts for capital that comes from equity sources (price per share).

Besides raising capital in the stock market in exchange for ownership, a company may also take out loans to finance projects and investments. The P/S ratio doesn’t take into consideration the weighted average cost of capital (WACC) — a weighted measure of the cost of capital from debt and equity sources. The WACC is a vital hurdle rate used to determine whether the return of an investment exceeds its cost or not.

Another limitation of the P/S ratio is that the gross revenue doesn’t account for a company’s profitability. Revenue is never negative, while profit may be negative. The use of revenue doesn’t account for the expenses necessary to achieve that revenue.

A third limitation is that the recognition of revenue varies from industry to industry. Two companies with different revenue recognition practices may not be accurately compared with the P/S ratio.