Price–sales ratio
The price-to-sales ratio is a financial ratio used to assess a company's market value relative to its revenue. It is calculated by dividing the company's market capitalization by its total revenue over a specified period, typically the trailing twelve months, or equivalently, by dividing the unit price of each share by the per-share revenue. Investors use this metric to gauge how much they are paying for each dollar of a company's sales, often as an alternative to the price-to-earnings ratio when earnings are negative or volatile.
The P/S ratio is particularly useful for valuing unprofitable companies, as it relies on revenue rather than profit, which may be absent or distorted by accounting practices. A lower ratio may suggest a stock is undervalued, while a higher ratio could indicate overvaluation, though interpretation depends on industry norms and company context. The ratio can also track a stock’s valuation over time or compare companies within the same sector.
Calculation
The price-to-sales ratio is expressed as:Market capitalization: The total value of a company's outstanding shares, calculated as stock price multiplied by the number of shares.Revenue: Total sales or income over a period, typically the trailing twelve months unless otherwise specified.A justified P/S ratio adjusts this metric based on fundamentals, derived from the Gordon Growth Model. It incorporates the profit margin, dividend payout ratio, sustainable growth rate, and required rate of return :
Here, the growth rate g is calculated as:
where the retention ratio is 1 minus the payout ratio, and return on equity reflects profitability relative to shareholders' equity.