Introduction to the Price to Sales Ratio for Stock Investors - dummies

Introduction to the Price to Sales Ratio for Stock Investors

By Paul Mladjenovic

The price to sales ratio (PSR) is a company’s stock price divided by its sales. Because the sales number is rarely expressed as a per-share figure, it’s easier to divide a company’s total market value by its total sales for the last 12 months.

As a general rule, stock trading at a PSR of 1 or less is a reasonably priced stock worthy of your attention. For example, a company has sales of $1 billion and the stock has a total market value of $950 million. The PSR is 0.95. In other words, you can buy $1 of the company’s sales for only 95 cents. All things equal, that stock may be a bargain.

Analysts frequently use the PSR as an evaluation tool in the following circumstances:

  • In tandem with other ratios to get a more well-rounded picture of the company and the stock.

  • When they want an alternate way to value a business that doesn’t have earnings.

  • When they want a true picture of the company’s financial health, because sales are tougher for companies to manipulate than earnings.

  • When they’re considering a company offering products (versus services). PSR is more suitable for companies that sell items that are easily counted (such as products). Firms that make their money through loans, such as banks, aren’t usually valued with a PSR because deriving a usable PSR for them is more difficult.

Compare the company’s PSR with other companies in the same industry, along with the industry average, so that you get a better idea of the company’s relative value.