Definition

The Price to Sales Growth (PSG) Ratio is a valuation metric that compares a company's stock price to its revenue growth. It is used to assess whether a stock is overvalued or undervalued relative to its sales growth.

Formula

PSG Ratio = (Price per Share / Revenue per Share) / Revenue Growth Rate

How to use the valuation method

Investors use the PSG Ratio to evaluate whether a company's stock price is justified by its sales growth. A lower PSG Ratio may indicate that the stock is undervalued relative to its sales growth, while a higher PSG Ratio might suggest overvaluation. It is particularly useful for comparing companies within the same industry.

Which industries it work best in

The PSG Ratio works best in industries with consistent and predictable revenue growth, such as technology and consumer goods, where sales growth is a key driver of valuation.

Which industries it does not apply to and why

The PSG Ratio may not be as applicable in industries with volatile or cyclical revenue patterns, such as commodities or utilities, because sales growth may not be a reliable indicator of future performance in these sectors.

Summary

The Price to Sales Growth (PSG) Ratio is a useful tool for evaluating whether a stock's price is aligned with its revenue growth. It is most effective in industries with stable growth patterns and less applicable in sectors with fluctuating revenues.