The price-to-sales ratio (P/S ratio) is used in the stock market to compare the market value of a company’s stocks with the same company’s annual sales. The lower a stock’s P/S ratio in comparison to those issued by other companies in the same industry, the more value that stock offers.
To find a stock’s price-to-sales ratio, the market capitalization of the issuing company is required. The price of the stock is then multiplied by the number of shares issued by the company. The resulting amount is then divided by the company’s total sales revenues.
If the market capitalization of a company sits at 1 billion francs, for example, and its sales revenues sit at 800 million francs, its stocks would have a 1.25 P/S ratio. For the sake of comparison: Normally, stocks which have P/S ratios below 1.0 are considered to be good value.
The P/S ratio can also be calculated by dividing stock prices by per-stock sales revenues. Results will match those delivered using the regular calculation method mentioned earlier.
In general, many investors prefer to follow a company’s profits then its gross sales revenues. For this reason, the price-to-earnings ratio is more commonly used. In many cases, the price-to-earnings ratio is more useful in determining the value of stocks, compared to the price-to-sales ratio, because it can reflect a company’s actual profitability.
But the P/S ratio can be beneficial in calculating the value of stocks issued by a company which is making losses. This is helpful because investing in a company which is making a loss is not always a bad idea. Some industries are highly dependent on the overall economic situation and due to this volatility, companies in these industries frequently make losses.
In cases like this, reviewing a company’s P/S ratios can pay off. This ratio can also be applied when valuating new companies which have not yet gotten out of the red.