Price-to-Sales (P/S) Ratio

What Is a P/S (Price-to-Sales) Ratio?

A P/S (or price-to-sales) ratio is a valuation tool is used by investors to determine how a company's share price compares to its annual revenue.
A company's P/S ratio can also be considered how much investors will pay for a stock per dollar of the underlying company's annual sales. It is one of numerous metrics that investors see when attempting to compare stocks or figure out whether a particular stock is undervalued or overvalued.
Average or "normal" P/S ratios fluctuate by industry. The higher a company's revenue compared to its share price, the lower its P/S ratio. The higher a company's share price compared to its revenue, the higher its P/S ratio. In the absence of other factors, some investors consider stocks with lower P/S ratios than similar companies in the same industry undervalued (and stocks with higher ratios overvalued).

What Are P/S Ratios Used For?

Similar as the slightly better-known P/E (price-to-earnings) ratio, the P/S ratio is a metric that allows investors to get a sense of the value of a stock by comparing its price (which is determined by the market) to something that really reflects how successful the company is — in this case, its annual revenue (sales, not profit).
While the P/E ratio compares a company's stock price to its annual earnings (profit), the P/S ratio compares its stock price to its annual revenue (sales). Not all companies make a profit each year — especially newer companies in growth phases and companies whose revenue is deeply affected by ups and downs in the economy — and this is not something terrible.
A lack of profit doesn't make a company a terrible investment. That is the reason the P/S ratio is so useful. It very well may be used to value and compare companies based on their revenue even on the off chance that they have yet to make money (or didn't make money over the last 12 months). Consequently, it's one of the most common fundamentals used to evaluate startups and other new or rapidly developing companies.

What Does a High P/S Ratio Mean?

A relatively high P/S ratio indicates that investors are currently able to pay more per dollar of annual sales for a particular company's stock than they are for other stocks in the same sector. This could mean that the company in question is overvalued by the market and wouldn't be a smart buy.
Then again, value is simply the thing the market will pay for something, so a high P/S ratio could also be taken to mean that company holds a ton of value that is not based solely on revenue.

What Does a Low P/S Ratio Mean?

A relatively low P/S ratio indicates that investors are currently ready to pay less per dollar of annual revenue for a particular company's stock than they are for other stocks in the same sector. This could mean that the company in question is undervalued by the market and may be a smart buy.
Then again, a low ratio could mean that market sentiment and other factors not related to sales could play a larger role in determining this particular stock's price. In the long term, however, stocks with low P/E and P/S ratios appeal to numerous investors.

The most effective method to Calculate P/S Ratio

To calculate a stock's P/S ratio, simply divide its market capitalization (the current value of all outstanding shares) by its year trailing revenue.

Formula 1

P/S = Market Capitalization/Trailing 12-Month Revenue
P/S = (Number of Outstanding Shares * Current Share Price)/Trailing 12-Month Revenue

Formula 2

P/S = Current Share Price/Trailing 12-Month Revenue per Share
P/S = Current Share Price/(Trailing 12-Month Revenue/Number of Shares Outstanding)

What Are the Limitations of the P/S Ratio?

Since the P/S ratio doesn't take earnings into account, it's anything but a decent indicator of how profitable a company is or whether a company will ever become profitable in the future. In other words, what makes it useful for evaluating newer endlessly companies in growth phases also makes it a somewhat restricting metric.
The P/S ratio also doesn't take debt into account. One company could have a much lower ratio than another in its industry, however that same company could also be highly leveraged (i.e., have a large amount of debt), while its competitor may be debt-free.
As is the case with most other metrics, a company's P/S ratio alone can't enable an investor to make an educated decision to buy or sell a stock. It's essential to take a gander at a number of fundamental factors — both quantitative and qualitative — when evaluating a company to gain a more holistic understanding of its financial and functional health.

Average P/S Ratios by Industry (Jan. 2022)

Highlights

• One of the downsides of the P/S ratio is that it doesn't take into account whether the company makes any earnings or whether it will ever make earnings.
• The price-to-sales (P/S) ratio shows how much investors will pay per dollar of sales for a stock.
• The P/S ratio is calculated by separating the stock price by the underlying company's sales per share.
• A low ratio could imply the stock is undervalued, while a ratio that is higher-than-average could indicate that the stock is overvalued.

FAQ

Do Cryptocurrencies Like Bitcoin Have P/S Ratios?

Some crypto investors truly do use a form of the P/S ratio to evaluate crypto projects. Similar as stock investors use P/S ratios to value newer companies or those in growth phases that have yet to report earnings, crypto investors might use a similar ratio to evaluate projects and protocols in the DeFi (decentralized finance) market, as most are still relatively new, and the crypto landscape is evolving rapidly.The ratio is calculated similarly (i.e., market cap is divided by year trailing revenue). In the crypto sphere, "year trailing revenue" generally means the total fees paid by a blockchain's users over the course of the past year. Crypto projects with lower ratios might be considered undervalued by some investors, however the crypto market is still relatively new and unpredictable, so metrics like this should be handled with alert.

Is a High or Low P/S Ratio Better?

While most investors consider lower P/S ratios to be preferable, neither a high nor low P/S ratio is inherently better. A low ratio indicates that the market will pay a relatively low price for each dollar of a company's sales, which could be a decent sign for investors hoping to identify and purchase undervalued stocks.A high ratio, then again, indicates that the market will pay a relatively high price for each dollar of a company's sales. This could mean that the company is overvalued, however it could also be a signal that investors and analysts see value in this company beyond its sales — perhaps it has a history of consistent growth or a product offering that is unique in its industry. Different industries have different norms, so comparing the P/S ratio of an airline to that of a dress company wouldn't provide meaningful information as to which company is in better shape or may be a better stock pick.Value investors who prefer to target undervalued companies and see continuous returns over the long term could prefer stocks with lower P/S ratios than other stocks in a particular industry. Investors with higher risk tolerance who are searching for more substantial returns in the short term could put more weight on relevant news and market sentiment than valuation and thus could focus less on P/S ratios.

What Is a Good P/S Ratio?

"Great" P/S ratios fluctuate by industry. While, as a general rule, ratios below 2 are typically considered healthy, and ratios below 1 are sometimes considered very great, a particular company's ratio must be compared to those of its competitors and the average ratio for its industry (see table above) to determine how "great" it is in relative terms. For instance, given the data above, a P/S ratio of 2 may be considered low (really great) for a restaurant chain, yet the same ratio may be considered high (potentially terrible) for a food wholesaler. It is normal for companies in different industries to have different P/S ratios, so comparing the P/S ratio of a restaurant to that of a food wholesaler would be like comparing apples to oranges, so to speak. A food wholesaler could have higher sales volume (and thus a lower ratio) however a smaller profit margin. A restaurant could have lower sales volume (and thus a higher ratio) however a larger profit margin. In other words, two companies could have identical earnings however different P/S ratios due to differences in their profit margins and sales volumes.

When Are P/S Ratios Most Meaningful?

P/S ratios are most useful for investors who need to compare the performance of two or more similar companies in the same industry, especially on the off chance that those companies haven't posted positive earnings over the last 12 months. Because this ratio compares stock price to sales instead of profit, it is often used to compare newer companies in a particular sector or industry that have yet to make a profit or more established companies in an industry that hasn't seen profit over the past 12 months due to economic cycles. Taking a company's P/S ratio into account can also be helpful any time you are considering adding it to (or removing it from) your portfolio. However, it is important to remember that metrics like this are most valuable when viewed alongside qualitative factors (like competitive advantage, management skill, etc.) and other quantitative metrics (like debt-to-equity ratio, free cash flow, etc.), as nobody number or piece of information can tell an investor everything they need to be familiar with a company's value.