Price to Sales (P/S) Ratio
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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.