Price to Sales Ratio Meaning
The price to sales ratio, or P/S ratio, is one of the metrics used by value investors to attempt to identify investment opportunities. In this article, we will provide a price to sales ratio definition, demonstrate how to calculate price to sales ratio and explain how it can be interpreted.
Table of Contents
What Is Price to Sales Ratio?
The P/S ratio compares a company’s current market value to its total revenue and, consequently, expresses how much the market values a company in terms of the revenue it produces.
As the P/S ratio is based solely on revenue, it is typically used when looking at the value of companies which are not yet profitable.
| P/S Ratio = Market Capitalisation / Revenue |
How to Calculate Price to Sales Ratio
In order to calculate price to sales ratio, you need to find a company’s market capitalisation and its total revenue.
Market capitalisation is the total market value of a company’s outstanding shares. It can be calculated by multiplying its current share price by the number of shares outstanding. Revenue can be found in a company’s most recent earnings.
Once both these figures have been established, simply divide the market cap by total revenue and, voila, you have the price to sales ratio.
Price to Sales Ratio Example
The P/S ratio is probably best understood with an example. As we mentioned earlier, it is typically used when analysing companies which are not yet profitable, so let’s look at such an example – ride-hailing company Lyft.
At the time of writing, Lyft’s latest closing price was $12.05, and it has 401,552,000 shares outstanding. Multiplying these figures together gives Lyft a market cap of around $4.84 billion at the time of writing.
Its total revenue for the year ended 31 December 2023 was $4.40 billion (number of shares outstanding and total revenue can be found in a company’s earnings announcement).
These figures result in a price to sales ratio of 1.1. But what does this tell us?
Price to Sales Ratio Interpretation
As we said earlier, the price to sales ratio expresses a company’s current market value in relation to its revenue. Subsequently, a P/S ratio of 1 would imply that a company’s shares are trading in line with the revenue which it generates.
A P/S ratio of less than 1 would imply that a company’s market value is less than the total amount of revenue it generates. Conversely, a P/S ratio of more than 1 means that the market currently values the company higherthan its total revenue. In the case of Lyft, at the time of writing, the market values Lyft at 1.1 times its total revenue.
Stocks with a low price to sales ratio could be undervalued, whereas a high price to sales ratio could imply that a company is overvalued.
But how can you tell if a price to sales ratio is low or high?
On its own, the price to sales ratio of a company doesn’t actually tell us an awful lot. Consequently, investors will compare a company’s P/S ratio with other similar companies which operate in the same industry. By doing this, investors are able to tell if the market undervalues or overvalues a company in relation to its competitors.
For example, we saw earlier that Lyft has a price to sales ratio of 1.1. If the average P/S for other companies in the same industry was 3, this tells us that, in terms of revenue, the market valued Lyft lower than its competitors.
Drawback of Price to Sales Ratio Analysis
Whilst the above example could mean that Lyft was undervalued in comparison with its competitors, investors should be wary of drawing too many conclusions from any one financial metric. There may be a perfectly valid reason as to why a company is priced lower, or higher, than the competition.
Price to sales ratio analysis looks exclusively at a company’s market value and revenue. It does not take any other factors into consideration.
A company may have a very low price to sales ratio but also be making monumental losses, or heavily laden with debt. Therefore, investors should always look beyond the P/S ratio when making investment decisions.
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FAQ
Is a low price-to-sales ratio good?
Generally speaking, the lower the P/S ratio, the better. To fully understand a company’s price to sales ratio, it should be compared to similar companies operating in the same industry. However, it is important to look beyond the P/S ratio at other factors.
What is the difference between P/S ratio and P/E ratio?
Whilst the price to sales ratio expresses a company’s current market value in terms of its revenue, the price to earnings (P/E) ratio expresses a company’s current market value in terms of its earnings.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
