Price to Sales Ratio

Price to Sales (P/S) Ratio helps the investors to value the firm by comparing the stock price to its revenue. This makes them understand that how much are they actually paying for a company for the actual operations conducted by it. This ratio is also useful for startups who have negative or zero profits but can be valued on the basis of their revenue generation.

Price to Sales Ratio is computed in the following manner:

            Price to Sales Ratio    = Market Cap / Total Sales     OR

                                                = Price per share / Sales per share

Generally, lower the ratio the better it is, as the share is considered to be undervalued.

This ratio can also be used as a substitute of Price to Earnings Ratio, where a company is having net loss, take for example for businesses with long gestation period. This ratio can also be beneficial to value peers in the same industry, in situations where earnings can be manipulated as per accounting practices. It is however advisable to look at all investment perspectives before forming a decision based on this ratio.

Let’s take an example of Suprajit Engineering and Jamna Auto:

In the above case, Jamna Auto having a price to sales ratio of 2.03x is considerably undervalued vis-à-vis Suprajit Engineering, having a higher P/S Ratio of 3.48. Thus, an investor using Price to Sales Ratio will prefer to invest in Jamna Auto rather than Suprajit engineering as he anticipates more growth in Jamna Auto.