Price to Sales Ratio

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Price to Sales Ratio Formula

The formula for price to sales ratio, sometimes referenced as the P/S Ratio, is the perceived value of a stock by the market compared to the revenues of the company. The price to sales ratio is calculated by dividing the stock price by sales per share. Sales per share uses the weighted average of shares for the time period evaluated, which is generally one year.

Revenues and sales are synonymous terms and can be found on a company's income statement. The price of the stock is the price listed on the stock exchange, or secondary market.

Use of P/S Ratio Formula

The price to sales formula can be used in lieu of the price to earnings ratio in situations where the company has a net loss. Also, some may give more relevance to the price to sales than the P/E ratio due to earnings can be manipulated based on accounting practices. However, it is important when evaluating an investment to look at all aspects of a company. Evaluating the changes of a company with multiple formulas at once may shed light on issues that may not be found by looking at each formula individually.

Issues with the P/S Ratio Formula

As with the P/E and P/BV formula, the price to sales ratio uses the share price in the numerator of the formula. According to efficient market theory, the market functions based on all information such that the price of a stock accurately denotes the inherent value of the stock at any given moment. However, opponents of the efficient market theory would suggest that the price of a stock is based on the perceived value of the stock.

Whether a stock price is based on perception or a rational calculated value plays on deeper philosophical questions of whether any individual or the market can possess the veridical value of a stock, assuming there is such.

Those that oppose efficient market theory would suggest that when using the price to sales formula an investor would need to keep in mind that the price of the stock is based on its perceived value by the market. This can become an issue because a stock that has a low price to sales may be considered by an individual as a good investment due to being undervalued whereas another individual may consider the investment to be poor compared to other companies in the same industry with a higher price to sales ratio.

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