• Accounting , Finance ,
• 25 Aug

Price to Sales Ratio is  valuation metric. It can be helpful for valuating new companies that are not yet profitable. It is a basic formula you can use when no earnings are available to base valuation on. A lower number Price to Sales Ratio can often mean a good value, but it can also signal that investors do not expect a lot of growth. A high Price to Sales Ratio means that investors expect growth rates to increase in the future and this is why they are willing to accept lower earnings in the current.

One thing to like about Price to Sales is that it is harder for an Accounting Department to game and manipulate. This can be a valuable tool in  finding cheap or undervalued stock.

Price to Sales Ratio

where

= Marketing Capitalization

= Total Revenue

Market Capitalization

To calculate the Market Capitalization, or Market Cap , you multiply the total number of outstanding shares by the share price. It is the total value of a publicly traded company. We rank Market Caps are into different ranges including Large-Cap consisting of Market Caps over 10B, Mid-Cap from 2B to 10B, and Small-Cap from 2B to 200M.

Total Revenue

Total Revenue is the total amount of sales and other sources of income. We find this at the the top of the income statement and this is why you may hear it said as “top line”. If you use the Accrual Accounting method, you include sales made on credit. In Cash Based Accounting, you only consider the revenue when you receive payment. Total Revenue is not Net Income, nor is it EBIT.

Other Considerations and Shortfalls of Price to Sales

A high Price to Sales Ratio that has a lot of hype can seem like a big money maker, but it comes with risk. Amazon is a great example of this. But not every company is Amazon and if those growth rates aren’t met, the stock can devalue very quickly. When you look at the S&P 500’s Price to Sales, you get an idea of how inflated the stock market is. A higher rate may signal a systemic overvaluation. This is an important consideration when you consider your portfolio mix. An overvalued stock market may signal future losses from business cycles. You may want to look at reducing the percentage of stocks in your investment portfolio in that case.

Also, please keep in mind to not use a single data point to completely evaluate a company. I know we say this in a lot of articles and that is because it is important. In researching for this article, there are many mentions in blogs about comparing the ratios to peers. Be careful in understanding the numerous variables that go into valuating companies and investments.