Definition

The Price to Sales (PS) Ratio is a financial metric used to evaluate a company's stock price relative to its revenue. It provides insight into how much investors are willing to pay per dollar of sales.

Formula

PS Ratio = Market Capitalization / Total Sales

How to use the valuation method

The PS ratio is used to assess whether a stock is undervalued or overvalued by comparing it to the company's historical PS ratio, the PS ratios of competitors, or the industry average. A lower PS ratio may indicate that the stock is undervalued, while a higher PS ratio might suggest overvaluation.

Which industries it work best in

The PS ratio works best in industries where companies have stable and predictable sales, such as consumer staples and retail. It is particularly useful for evaluating companies with consistent revenue streams but varying profit margins.

Which industries it does not apply to and why

The PS ratio is less applicable to industries with volatile sales or where companies are not yet profitable, such as technology startups or biotech firms. This is because the ratio does not account for profitability, which can be a critical factor in these sectors.

Summary

The Price to Sales (PS) Ratio is a useful tool for evaluating a company's stock price relative to its revenue, especially in industries with stable sales. However, it has limitations in sectors with volatile sales or where profitability is a key concern.