Price to Sales Ratio (P/S) - Financial Glossary

Overview

The price to sales (P/S) ratio is a valuation ratio that measures a company's stock price (market capitalization) compared to its revenues (also known as sales). It is an indicator of the "value" investors are placing on the company's revenue.

The price to sales ratio is an easy way to understand the valuation of a company. It is especially useful for doing valuation on new companies and startups that do not have (yet) net income or assets to base the valuation on.

Alternative Names: PS, Price to Revenue, P/S Ratio, PSR, Sales Multiple, Revenue Multiple, Price–Sales Ratio

Formula

The price to sales ratio can be calculated using either total company values or on a per-share basis:

Primary Formula (Total Company):

Price to Sales Ratio = Market Cap ÷ Revenue

Alternative Formula (Per Share Basis):

Price to Sales Ratio = Share Price ÷ Revenue Per Share

Where:

Market Cap: Total market capitalization (share price × total shares outstanding)
Revenue: Total company revenue (sales), found on the income statement
Revenue Per Share: Total revenue divided by shares outstanding

Note: Price to sales ratio is usually calculated for the trailing twelve months (TTM) revenue data, unless stated otherwise.

Calculation Example

Let's calculate the price to sales ratio for a hypothetical company to demonstrate the process:

Example Company - Financial Data:

Market Capitalization: $2 billion
Annual Revenue (TTM): $500 million

Calculate Price to Sales Ratio

P/S = $2,000M ÷ $500M

= 4.0x

Interpretation: A P/S ratio of 4.0 means investors are paying $4 for every $1 of annual revenue the company generates. This indicates the market is valuing the company at 4 times its total sales.

How to Interpret

Since the P/S ratio is a valuation ratio, generally a lower P/S ratio is considered better as it is a sign that the company's stock is undervalued. However, interpretation depends heavily on growth expectations and industry characteristics.

General Guidelines:

Low P/S Ratio (Below 1.0-2.0): Potentially Undervalued

Lower P/S ratios generally indicate the stock may be undervalued relative to its revenue generation. This can represent a buying opportunity if fundamentals are strong, though it may also reflect concerns about profit margins, growth prospects, or operational challenges.

Moderate P/S Ratio (2.0-5.0): Fairly Valued

P/S ratios in this range are typical for many established companies. The valuation aligns with industry norms and market expectations, suggesting reasonable pricing relative to revenue generation.

High P/S Ratio (Above 5.0): Growth Premium

Companies that have higher growth expectations typically have higher P/S ratios, as investors are willing to pay a premium for the growth potential. This is common for high-growth startups, technology companies, and companies in emerging markets. However, this carries higher risk if growth expectations are not met.

Critical Context: The P/S ratio can vary significantly from industry to industry or sector to sector. It is better to use it in comparison with similar types of businesses operating within the same industry or sector. Software companies typically have higher P/S ratios than retail businesses, for example.

Why It Matters

The main operation in any business is to generate revenue (and profits) from the sale of goods and services. The P/S ratio provides valuation based on the operations of the company without any accounting adjustments, making it useful for specific scenarios.

Key Insights:

Startups and New Companies Valuation: Especially useful for valuing new companies and startups that do not have (yet) net income or substantial assets to base the valuation on. Since many early-stage companies are unprofitable, P/S provides a way to compare valuations using revenue.
Operations-Based Valuation: Provides rough idea of business valuation in different industries and sectors based purely on revenue generation without accounting adjustments like depreciation, amortization, or one-time charges.
Revenue Comparison Across Industries: Enables comparison of how much the market values each dollar of sales across different companies and sectors, helping identify relative value.
Complement to Other Metrics: Works well alongside P/E ratios (which require earnings) and P/B ratios (which require assets), providing a fuller valuation picture especially for high-growth companies with negative or volatile earnings.

Important Limitations: Since the P/S ratio does not include any type of accounting adjustment, be aware of its limitations:

Does not account for leverage used by the company (debt levels)
Provides no information about the profitability of the business
Does not reflect the cost of doing business or operational efficiency
Does not consider profit margins, which vary widely across industries

Key Takeaways

The P/S ratio measures stock price (market cap) compared to revenues, showing the value investors place on company revenue
Calculated as Market Cap ÷ Revenue or Share Price ÷ Revenue Per Share, usually for trailing twelve months (TTM)
Especially useful for valuing new companies and startups that do not yet have net income or substantial assets
Generally, a lower P/S ratio is considered better as it indicates potential undervaluation
Companies with higher growth expectations typically have higher P/S ratios as investors pay a premium for growth potential
Provides valuation based on operations without accounting adjustments like depreciation or one-time charges
P/S ratios vary significantly by industry and sector—always compare within the same industry
Does not account for leverage, profitability, cost of doing business, or profit margins
Works best as a complement to other metrics like P/E and P/B for comprehensive valuation
Low P/S (below 1-2) may indicate undervaluation, moderate (2-5) suggests fair value, high (above 5) reflects growth premium

Related Financial Ratios

These related metrics provide additional insights for comprehensive financial analysis:

Price to Earnings Ratio (P/E)

Compares stock price to earnings per share. Requires profitability, so P/S is often used for companies that are not yet profitable or have negative earnings.

Price to Book Ratio (P/B)

Compares market value to book value of equity. Works best for asset-heavy companies, while P/S is better for asset-light businesses focused on revenue generation.

EV/Sales Ratio

Similar to P/S but uses enterprise value instead of market cap, accounting for debt and cash. Provides more comprehensive valuation by considering capital structure.