Updated February 2019
The price-to-sales (p/s) ratio is the market capitalisation of a company divided by its revenues. So a company that has a market value of £25bn and sales of £10bn has a p/s ratio of 2.5. This is sometimes also known as a “sales multiple”. All else considered, the lower the number, the cheaper the stock. The p/s is calculated in a similar way to other metrics such as the price/earnings (p/e) ratio (market capitalisation divided by profits). But of course, sales aren’t the same as profits, so the p/s may at first glance appear less useful as a gauge of whether a firm is cheap or not.
However, it can be a helpful tool when looking at firms or sectors where earnings are temporarily depressed as a result of one-off factors, but which are later expected to return to a more normal level (as is often the case with companies in cyclical industries). Comparing companies using p/s rather than p/e may be more effective in this case. It may also be used when comparing early stage growth stocks operating in the same industry. Again, these firms may be expanding rapidly, but not yet making a profit, rendering the p/e useless. By comparing them based on p/s, an investor can work out how much the market is paying for each pound or dollar of sales.
However, investors must ensure any assumptions they make about how profitable a company will be in the future are realistic. A business with a low p/s ratio but no prospect of ever achieving a profit will be a poor investment. Also, as with the p/e ratio, the p/s ratio does not take any debt into account. Generally a heavily indebted company is riskier and less appealing than one that has no debt at all (assuming you are comparing companies within the same industry). To get a picture that includes debt, you need to find the enterprise value (EV) – which adds debt to the market cap – and divide it by sales. Overall, as with all ratios, p/s should not be used in isolation.
• Watch Tim Bennett’s video tutorial: What is the price-to-sales ratio?