Price to sales ratio definition
/What is the Price to Sales Ratio?
The price to sales ratio values a business by comparing the market price of its stock to its net sales. In essence, the ratio shows the value that the market is placing on each dollar of sales that a business is generating.
How to Calculate the Price to Sales Ratio
The ratio is calculated by dividing the market capitalization of a firm by its annual net sales. The formula is:
(Market price per share x Number of shares outstanding) ÷ Annual net sales = Price to sales ratio
The information in the formula may be updated to include an organization's most recent quarterly earnings announcement. The ratio is tracked both on a trend line and in comparison to the same ratio for other firms in the same industry. When the ratio is low or declining in either comparison, it may indicate that the stock is currently undervalued and so should be purchased. However, such a decline may also indicate that there are problems with the firm, such as poor management or an old product line, that are causing the decline.
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Problems with the Price to Sales Ratio
The price to sales ratio only includes the sales of a business, not its profits or cash flows, and so may not be a good indicator of the actual value of a business, though it can be useful when there are no reported profits. Consequently, if this metric is to be used at all, it should be in conjunction with other metrics that focus on other aspects of the organization. Another concern is that the ratio is only useful for the shares of publicly-held companies, since there is no market price for the shares of privately-held businesses.