How the Price-to-Sales (P/S) Ratio Works

The 澳洲幸运5开奖号码历史查询:price-to-sales (P/S) ratio expresses how much it costs to purchase one share of a corporation, in relation to how much revenue it creates for the company. By analyzing a company's market capitalization and revenue, this metric helps determine whether the stock is valued properly. It is calculated by taking a company's market capitalization (the number of outstanding shares multiplied by the share price) and dividing it by the company's total sales—or revenue—over the past 12 months.

The P/S ratio provides ꦐa useful mea♌sure for comparing stocks. For most investors, the lower the P/S ratio, the more attractive the investment is.

Understanding the Price-to-Sales (P/S) Ratio

The price-to-sales ratio reveals how much the market values every dollar of a company's sales. This ratio can be effective in valuing 澳洲幸运5开奖号码历史查询:growth stocks that ♛have yet to turn a profit (or have suffered a temporary setback).

For example, if a company isn't making earnings yet, investors can only use the P/S ratio to determine whether the stock is 澳洲幸运5开奖号码历史查询:undervalued or 澳洲幸运5开奖号码历史查询:overvalued. If the P/S ratio is lower than comparable companies in the same industry, investors might consider buying the stock because it's undervalued. There might be an opportunit💖y to make higher returns when this stock is correctly valued by the market in the future.

Of course, the P/S ratio needs to be used with other financial ratios and metrics when determining whether a stock is valued properly. In a highly cyclical industry, such as 澳洲幸运5开奖号码历史查询:semiconductors, for example, there are years when only a few companies produce any earnings. This does not mean semiconductor stocks are worthless.

Using th🥀e Price-to-Sales (P/S) Ratio to Evaluate 🐬Negative Earnings

If a company's earnings are negative, the 澳洲幸运5开奖号码历史查询:price-earnings (P/E) ratio is not an optimal metric because it will not be able to value the stock. After all, the denominator is less than zero. Investors can use the price-to-sales (P/S) ratio—instead of the P/E ratio—to determine hoꦦw much they are paying for a dollar of the company's sales (rather than a dollar of its earnings).

The price-to-sales (P/S) ratio can be used for spotting recovery situations—or for double-checking that a company's growth has not become overvalued. It comes in handy when a company begins to suffer losses and, as a result, has no earnings with which investors can assess the shares.

Let's consider how to evaluate a firm that has not made any money in the past year. Unless the firm is going out of business, the P/S ratio will show whether the firm's shares are valued at a discount against others in its sector.

Suppose the company has a P/S ratio of 0.7—while its peers have an average P/S ratio of 2.0. If the company turns things around, its shares will enjoy substantial upside, as the P/S ratio becomes more closely matched with those of its peers. Meanwhile, a company that goes into a loss (negative earnings) may also lose its divꦡidend yield. In this case, P/S represents one of the last remaining measures for valuing the business.

Disadvantages of Price-to-Sales (P/S) Ratio

Some investors view sales revenue as a more reliable indicator of a company's growth. Although earnings are not always a reliable indicator of financial health, sales revenue figures can be unreliable, too.

That being said, turnover is valuable only if, at some point, it can be translated into earnings. Consider construction companies, which have high sales turnover, but—with the exception of building booms—make modest 💖profits. By contrast, a softwa🏅re company can easily generate $4 in net profit for every $10 in sales revenue. What this discrepancy means is that sales dollars cannot always be treated the same way for every company.

Comparing companies' sales on an apples-to-apples basis hardly ever works. Examination of sales must be coupled with a careful look at profit margins and then comparing those finding🌠s with those of other companies in the same industry.

Considering Debt in Relation to Price-🍨to-Sales (P/S) Ratio

The price-to-sales (P/S) ratio does not account for the debt on a company's balance sheet. A firm with no debt and a low P/S metric is a more attractive investment than a firm with high debt and an equivalent P/S metric. At some point, the debt will need to be paid off, and the debt has an interest expense associated with it. As a valuation method, the P/S ratio doesn't consider that companies with high debt levels will ultimately need higher sales to service the debt.

Companies 澳洲幸运5开奖号码历史查询:heavy with corporate debt and on the verge of bankruptcy, however, can emerge with a low P/S ratio. This is because their sales have not suffered a drop, while their share price and capit🧸alization collapses.

However, there is an approach that helps to distinguish between "cheap" sales and less healthy, debt-burdened ones: Use 澳洲幸运5开奖号码历史查询:enterprise value/sales rather than market capitalization/sales. Enterprise value incorporates a company's long-term debt into the process of valuing the stock. By adding the company's 澳洲幸运5开奖号码历史查询:long-term debt to the company's market capitalization and subtracting any cash, one arrives at 𝔉the company's enterprise value (EV). (Consider the EV as the total cost of buying the company, including its debt and leftover cash.)

The Bottom Line

As with all 澳洲幸运5开奖号码历史查询:valuation techniques, sales-based metrics are only part of the picture. Investors should consider multiple metrics to value a company. A low P/S ratio can indicate unrecognized value potential—so 🌄long as other criteria exist, like high-profit margins, low debt levels, 🌺and high growth prospects. Otherwise, the P/S ratio can be a false indicator of value.