What is the Price to Sales (P/S) Ratio?
The Price to Sales Ratio is a method of evaluating a business based on the price of its stock and revenue.
The Price to Sales ratio can be calculated 2 ways; based on market cap and total revenue, or on a per share basis based share price and revenue per share.
First way, based on market cap and total revenue:
Second way, based on the company’s stock price and revenue per share:
Revenue per share is calculated by taking the total revenue and dividing by the number of shares outstanding (which is found on a company’s income statement).
For an example on calculating a company’s P/S ratio, lets look at Intel’s (INTC) 2011 10- k annual report, which can be found here:
At time of writing, Intel is trading at $21.80 a share, with 5.4 billion shares outstanding (and therefore a market cap of about $117 billion).
Market Cap ÷ Revenue = $117 Billion ÷ $54 billion = 2.16 Price to Sales Ratio
Or,
Share Price ÷ (Revenue ÷ Share Outstanding) = $21.80 ÷ ($54 Billion ÷ 5.4 billion shares) = 2.18 Price to Sales Ratio
(The small difference is due to rounding.)
Investors can then see that by purchasing Intel’s stock today they are paying about $2.16 for each $1 in sales. Investors can compare that ratio to Intel’s competitors to see if Intel’s stock is trading at a premium or a discount compared to their competitors stock.
The Price to Sales (P/S) ratio is preferred by some analysts over a Price to Earnings (P/E) ratio because earnings are easier for a company to “fudge” then sales. By looking at a company’s sales an investor can get a true picture of the outstanding demand for a company’s product.
Generally a lower P/S ratio indicates better value for investors. However it is important to note that investors should not base a decision to invest in a company solely on its P/S ratio. Investors need to take income and other figures into account before investing in a company.
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