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What is the Price-to-Sales (P/S) Ratio?
The P/S ratio is a valuation metric that is commonly used to compare how “expensive” a stock is relative to others within the same industry.
The P/S ratio helps investors understand how much value the market puts on each dollar of revenue a company generates.
Understanding Price-to-Sales (P/S) Ratio
The P/S ratio is one of many valuation metrics investors can use to determine whether they believe a stock is overvalued.
Others include price-to-earnings (P/E) and price-to-book (P/B). It’s common to take the stock price and divide it by some other financial number associated with the company. Some chosen denominators are more useful than others.
Investors typically turn to P/S ratios when they’re trying to evaluate growth stocks, considering many of these high-flying companies are still unprofitable.
It’s important to supplement P/S ratios with context. A low P/S ratio relative to the industry’s average does not mean a company is necessarily “undervalued,” and a high P/S ratio does not make it “overvalued.”
How to Calculate P/S Ratio
The P/S ratio is relatively simple to calculate, but there are some things to understand before you use it to avoid misinterpretations.
To calculate a company’s P/S ratio, you’ll need the current stock price and amount of sales.
To find the sales value, you need to locate the company’s reported revenue on the most recent earnings statement.
Then, you can find the number of shares of stock outstanding the company has on its books, which can be found on any free stock analysis websiteonline.
Divide the company revenues by the number of shares outstanding to arrive at the revenue per share figure.
Finally, divide the current stock price (dollars per share) by the revenue-per-share figure (also dollars per share), and you have your very own P/S ratio!
Here is the formula to calculate the P/S ratio:
P/S Ratio = Current Stock Price / Revenue Per Share
How to Use Price-to-Sales to Value Stocks
Since the markets are moving so fast, good opportunities could come and go before investors can analyze even a single earnings statement. This is where the P/S ratio comes in.
By using the P/S ratio in conjunction with other indicators, investors can analyze multiple stocks simultaneously to decide whether they fit within their investing strategy.
Specifically, the P/S ratio will give investors an idea of whether a company’s stock price is overvalued or undervalued compared with the revenues it brings in or relative to other stocks in the same industry.
Ideally, the P/S ratio is used to compare several peer companies, meaning the companies sell similar products and services or are trying to do the same thing. Think of semiconductor stocks like Intel, Nvidia, and AMD – all chip makers.
If one of them has a P/S ratio that is far above the others, investors can use that as an indicator that the stock might be a bit too expensive compared with competitors.
Alternatively, a low P/S value compared to competitors could point to a good buying opportunity.
Comparing the P/S ratio of Nvidia to Chipotleis not useful as they are entirely different businesses.
Price-to-Sales Ratio Example
Let’s use the three companies mentioned above to show an example. First, let’s calculate the P/S ratio for Intel (NASDAQ: INTC).
The most recent closing stock price for INTC was $53.86 per share, and the most recent earnings reports showed $77.61 billion. The last piece of information needed to calculate P/S is the outstanding shares, which is 4.05 billion.
First, calculate the earnings per share:
$77.61 billion / 4.05 billion shares = $19.16 revenue/share
Then, calculate the P/S ratio:
P/S Ratio = $53.86 / $19.16 = 2.81
Let’s quickly compare this to the other two peer companies. AMD has a P/S ratio of 9.36, and NVDA has a P/S ratio of 23.65.
All other things being equal, you would note the fact that NVDA has a P/S value quite a bit higher than its competitors.
While there are other things to consider, NVDA would be considered overpriced compared to its competitors.
However, for a good reason, Nvidia might trade at a premium, and Intel might trade at a discount. Don’t forget context when using P/S ratios.
P/S Ratio FAQs
What is a good price-to-sales ratio?
A good P/S ratio depends on what investing strategy you are employing. If you are a value investor, you would favor companies with very low P/S values, ideally under 5-8 or so. If you favor growth companies, you will want to find higher P/S values and examine the growth opportunities the company is exploring.
Is the PS ratio always a good indicator of a company’s value?
Not necessarily. While the P/S ratio puts a company’s revenue in compatible terms with other companies, it’s important to note that the ratio does not consider certain fundamental considerations about each company.
For instance, while all three of the chip-making companies used earlier are direct competitors, Nvidia and AMD are more focused on consumer graphics processors for video games, whereas Intel is more focused on PC processing units.
How are PS and PE different?
Both of these are important ratios for investors, but it’s especially important to compare them side-by-side because they tell a different story. The P/S ratio compares the revenues of companies, while the P/E ratio compares the earnings or profitsof a company.
Revenues show the money a company brings in from all sources, but earnings show the profits after all expenses are taken out. If the P/S is high, but the P/E is relatively low in comparison, this might mean a company is spending too much in overhead to earn its profits.
Bottom Line: Price-to-Sales Definition
P/S is one of several ratios that allow investors to compare several companies on a relatively even playing field. Companies have various revenue and outstanding share numbers, so these ratios help put things in a quick comparison perspective.
While there are a few drawbacks to using P/S alone, combining different indicators can help you find opportunities that fit your strategy.