The market value of a company (its market capitalisation) is simply the number of shares the company has in issue multiplied by the market price of a single share. That market cap divided by the company’s annual sales (or revenue) gives us the price to sales ratio (PSR). The ratio can also be found by dividing the price of one share by the company’s revenues per share.
The PSR tells us how many years it will take the company to sell goods to the value of its market cap. If, for example, the PSR is three, we know that, assuming sales stay level, it will take three years. Sales figures are much harder to manipulate than earnings, so if a p/e looks suspect, the PSR offers something of a reality check. Generally speaking, a PSR below one means a firm is cheap, as its market cap is less than its sales.
• Watch Tim Bennett’s video tutorial: What is the price-to-sales ratio?