Understanding the Price-to-Sales (P/S) Ratio: A Strategic Investor’s Friend
The Price-to-Sales (P/S) Ratio, a strategic asset in your investment toolkit, sheds light on how much the financial markets value each dollar of a company’s sales or revenues. This illuminating ratio is an anchor for investors keen on translating market movements into profitable ventures.
Key Insights
- Investor Enthusiasm: The P/S ratio reveals how much investors are willing to pay per dollar of sales.
- Clear Calculation: It’s computed by dividing the stock price by the company’s sales per share.
- Value Indicator: A low P/S ratio might signal an undervalued stock, while a high P/S ratio may suggest overvaluation.
- Limitations: This ratio doesn’t factor in whether a company is profitable or will ever turn a profit.
Diving Deeper into the Price-to-Sales (P/S) Ratio
Understanding the mechanics of the P/S ratio hinges on familiarity with several core financial metrics. Most crucially, it shows how much investors pay for each unit of sales. It can be calculated by dividing market capitalization by the company’s total sales over a designated period, usually twelve months, or on a per-share basis.
Real-World Application: Acme Co.
To demystify the P/S ratio, let’s analyze Acme Co.:
Sales Data Over Time (Millions USD):
| Term | Revenues |
|---|---|
| FY1-Q1 | $100 |
| FY1-Q2 | $110 |
| FY1-Q3 | $120 |
| FY1-Q4 | $125 |
| FY2-Q1 | $130 |
| FY2-Q2 | $135 |
| FY2-Q3 | $130 |
| FY2-Q4 | $125 |
With 100 million outstanding shares and a share price of $10, let’s calculate:
- TTM Sales: $455 million
- Sales per Share (TTM): $4.55
- P/S Ratio: 2.2 ($10 / $4.55)
Comparatively, let’s look forward:
- Forecast Sales for FY2: $520 million
- Sales per Share: $5.20
- P/S Ratio: 1.92 ($10 / $5.20)
Acme is trading at a premium compared to its peers with an average P/S ratio of 1.5 due to its strong revenue growth forecast.
Prestigious Benchmark: Apple Inc.
Consider Apple’s fiscal 2020 revenues of $274.5 billion, with 16.53 billion outstanding shares and a share price of $145:
- Sales per Share: $16.60
- P/S Ratio: 8.73
Compared to Google (P/S: 6.29) and Microsoft (P/S: 10.87), Apple and Google might be undervalued, or Microsoft might be overvalued.
Maximizing Investor Insights with the P/S Ratio
The P/S ratio stands as a tower for investors seeking clarity in their financial evaluations. It shows the price investors buck up per dollar of sales, reflecting potential undervaluation or overvaluation but must be used contextually within the same sector.
A Peek into Limitations
Despite its utility, the P/S ratio does not take into account the profitability or financial stability of the company, making it less reliable across different industries.
Leveraging Enterprise Value-to-Sales (EV/Sales)
The EV/Sales ratio refines this approach by factoring in enterprise value, adding debt, and preferred shares to market cap, then subtracting cash, providing a superior comparison tool involving more comprehensive financial steps.
Related Terms: market capitalization, revenues, sales per share, trailing 12 months, enterprise value-to-sales ratio.
References
- U.S. Securities and Exchange Commission. “Form 10-K Apple Inc. 2020”.
- Financial Times. “AAPL”.
- Yahoo Finance. “Apple Inc. Quote History”.
- Macrotrends. “Microsoft Price to Sales Ratio 2006-2020 | MSFT”.
- Macrotrends. “Alphabet Price to Sales Ratio 2006-2020 | GOOGL”.
