Price to Sales (P/S) Ratio

P/S = Market Price per Share / Sales per Share

P/S Positives

  • Sales can be more difficult for management to manipulate than earnings or book value.
  • While earnings can be negative, sales are never negative.
  • Sales can be more consistent than earnings.
  • P/S can be useful for analyzing companies with no earnings, are cyclical, or have reached maturity.
  • Stock return trends can be analyzed within the context of differences in P/S values.

P/S Drawbacks

  • Unprofitable companies can still show sales growth.
  • P/S ratio does not reflect cost structure.
  • Different companies may have different revenue recognition policies.

Fundamental View of P/S Ratio

P0/S0 = [(Earning0/Sales0) × (Payout ratio) × (1 + Growth rate)] / (rce - g)

For a justified P/S ratio:

  • The P/S ratio increases as profit margin and sales growth increases.
  • The P/S ratio decreases as the required rate of return on common equity increases.

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