Understanding the Price-to-Sales Ratio (P/S Ratio) as an Investor

As an investor, you are constantly looking for data to help you make informed investment decisions. One metric used by investors is the price-to-sales ratio (P/S ratio). In this article, we will delve into the P/S ratio, how to calculate it, when to use it, and why investors rely on it.

What is the Price-to-Sales Ratio (P/S Ratio)?

The P/S ratio is a valuation metric that compares a company's market capitalization to its revenue. Put simply, the P/S ratio tells investors how much they are willing to pay per dollar of revenue.

How to Calculate the P/S Ratio?

There are two ways to calculate the P/S ratio:

1. Take the current market capitalization of a publicly traded company and divide it by its latest full-year revenue.
2. Take the share price and divide it by the revenue per share.

For example, let's calculate the P/S ratio for Snap Inc. The market capitalization of Snap Inc is $17.2 billion, and the latest full-year revenue is $4.6 billion. Therefore, dividing the market capitalization by revenue gives a P/S ratio of 3.7. Alternatively, dividing the share price of $10.88 by revenue per share of $2.91 gets the same P/S ratio of 3.7.

You can also use a stock-tracking website like Simply Wall Street to retrieve up-to-date data and make the calculation easier.

When to Use the P/S Ratio Rather Than the Price-Earnings (P/E) Ratio?

The P/E ratio is another metric used by investors. However, the P/E ratio is not suitable for all scenarios, especially in cases of a company making a loss and/or growing rapidly in revenue. In these cases, investors turn to the P/S ratio as an indicator of relative value between companies.

Why Do Investors Use the P/S Ratio?

Investors use P/S ratios to analyze whether a stock is overvalued or undervalued and to find investment opportunities. For example, if Snap Inc's P/S ratio of 3.7 is compared to Pinterest's P/S ratio of 7, investors may consider Pinterest overvalued and Snap Inc undervalued.

Comparison Analysis with P/S Ratio

When dealing with the P/S ratio, it's better to use it in comparison for better analysis. The comparison can be made with relevant peers or the industry average.

For example, you can compare Snap Inc's P/S ratio of 3.7 to the industry average, which is 1.6 for the US interactive media and services industry. This comparison suggests that Snap Inc may be overvalued.

Historical analysis is also useful in generating insight through a comparison of the current P/S ratio to previous P/S ratios. For instance, Snap Inc had a P/S ratio as high as 30 in the past. The current P/S ratio of 3.7 is the lowest P/S ratio in years, but there's still uncertainty whether it will go back up, stay constant, or continue to drop in the years to come.

Conclusion

The P/S ratio is an important metric used by investors to compare the market value of a company to its revenue. It provides an indication of whether a stock is overvalued or undervalued and uncovers investment opportunities. In combination with other metrics and analysis, like the price-earnings ratio, the P/S ratio can provide insight into whether to buy, sell, or hold a stock. However, it's important to remember that the P/S ratio is just one of many tools available to investors and should not be used as the sole criterion for investment decisions.