Price–sales ratio

Calculation

The price-to-sales ratio is expressed as:

: \text{P/S Ratio} = \frac{\text{Market Capitalization}}{\text{Revenue}} = \frac{\text{Stock Price per Share}}{\text{Revenue per Share}}

• Market capitalization: The total value of a company's outstanding shares, calculated as stock price multiplied by the number of shares.
• Revenue: Total sales or income over a period, typically the trailing twelve months (TTM) unless otherwise specified.

A justified P/S ratio adjusts this metric based on fundamentals, derived from the Gordon Growth Model. It incorporates the profit margin, dividend payout ratio, sustainable growth rate (g), and required rate of return (r):

: \text{Justified P/S} = \text{Profit Margin} \times \text{Payout Ratio} \times \frac{1 + g}{r - g}

Here, the growth rate g is calculated as:

: g = \text{Retention Ratio} \times \text{Return on Equity}

where the retention ratio is 1 minus the payout ratio, and return on equity (ROE) reflects profitability relative to shareholders' equity.

Interpretation

A low P/S ratio may indicate a potential bargain, but it does not account for profitability or expenses, limiting its standalone usefulness. It is most effective for unprofitable firms lacking a P/E ratio or for comparing similar companies within a sector, where revenue patterns are more consistent. However, P/S ratios vary widely across industries due to differences in typical capital structures (e.g., technology vs. utilities), making cross-sector comparisons less reliable.

References

References

1. "Price-to-Sales Ratio (P/S Ratio)". Investopedia.
2. "Price-to-Sales Ratio (P/S)". Corporate Finance Institute.
3. "Justified Price-to-Sales ratio".