What is the Price-Sales (P/S) Ratio?
The price-sales (P/S) ratio is a valuation ratio that compares a company’s current share price to its revenues.
How to Calculate the Price-Sales (P/S) Ratio
To calculate the P/S ratio, divide the current market share price by the revenue per share of the reporting period.
A publicly traded company’s market share price is readily found online, and the revenue per share can be calculated by dividing net sales by the weighted-average common shares outstanding.
How to Interpret the P/S Ratio
A low P/S ratio suggests that a stock may be cheap, and a high P/S ratio that a stock may be expensive.
To get a better idea about whether a company’s stock is actually cheap, the P/S ratio should be compared to competitors in the same industry, and to historic P/S ratios of the same company.
Advantage of the P/S Ratio
One advantage of the price-sales (P/S) ratio as a relative valuation measure is that it can be used for relatively new companies that have not yet achieved profitability, or for established companies that decide to invest heavily in growing the business, resulting in only low or no earnings.
In contrast, for the price-earnings (P/E) ratio and the price-free cash flow (P/FCF) ratio to be useful as relative valuation measures, a company needs to be profitable.
Limitations of the P/S Ratio
Since revenue is the first item on a company’s income statement, a limitation of the price-sales (P/S) ratio as a relative valuation measure is that it does not factor in any expenses, whereas the P/E and the P/FCF ratios do.
Looking at the P/S ratio alone might be misleading, for example if a company grows revenues year after year while at the same time increasing its net losses. To get a full picture, additional relative valuation ratios such as P/E, P/FCF, and absolute valuation tools like discounted cash flow (DCF) should be used.