What Is a P/S (Price-to-Sales) Ratio?
A P/S (or price-to-sales) ratio is a valuation tool is used by investors to determine how a company’s share price compares to its annual revenue. A company’s P/S ratio can also be thought of as how much investors are willing to pay for a stock per dollar of the underlying company’s annual sales. It is one of many metrics that investors look at when trying to compare stocks or figure out whether a particular stock is undervalued or overvalued.
Average or “normal” P/S ratios vary by industry. The higher a company’s revenue compared to its share price, the lower its P/S ratio. The higher a company’s share price compared to its revenue, the higher its P/S ratio. In the absence of other factors, some investors consider stocks with lower P/S ratios than similar companies in the same industry undervalued (and stocks with higher ratios overvalued).
What Are P/S Ratios Used For?
Much like the slightly better-known P/E ratio, the P/S ratio is a metric that allows investors to get a sense of the value of a stock by comparing its price (which is determined by the market) to something that actually reflects how successful the company is—in this case, its annual revenue (sales, not profit).
While the P/E ratio compares a company’s stock price to its annual earnings (profit), the P/S ratio compares its stock price to its annual revenue (sales). Not all companies make a profit each year—especially newer companies in growth phases and companies whose revenue is deeply affected by ups and downs in the economy—and this is not a bad thing.
A lack of profit doesn’t make a company a bad investment. That’s why the P/S ratio is so useful. It can be used to value and compare companies based on their revenue even if they have yet to turn a profit (or didn’t turn a profit over the last 12 months). For this reason, it’s one of the most common fundamentals used to evaluate startups and other new or rapidly growing companies.
What Does a High P/S Ratio Mean?
A relatively high P/S ratio indicates that investors are currently willing to pay more per dollar of annual sales for a particular company’s stock than they are for other stocks in the same sector. This could mean that the company in question is overvalued by the market and would not be a smart buy. Then again, value is simply what the market is willing to pay for something, so a high P/S ratio could also be taken to mean that company holds a lot of value that is not based solely on revenue.
What Does a Low P/S Ratio Mean?
A relatively low P/S ratio indicates that investors are currently willing to pay less per dollar of annual revenue for a particular company’s stock than they are for other stocks in the same sector. This could mean that the company in question is undervalued by the market and might be a smart buy. On the other hand, a low ratio could mean that market sentiment and other factors not related to sales might play a larger role in determining this particular stock’s price. In the long term, however, stocks with low P/E and P/S ratios appeal to many investors.
How to Calculate P/S Ratio
To calculate a stock’s P/S ratio, simply divide its market capitalization (the current value of all outstanding shares) by its 12-month trailing revenue.
P/S = Market Capitalization / Trailing 12-Month Revenue
P/S = (Number of Outstanding Shares * Current Share Price) / Trailing 12-Month Revenue
P/S = Current Share Price / Trailing 12-Month Revenue per Share
P/S = Current Share Price / (Trailing 12-Month Revenue / Number of Shares Outstanding)
TheStreet Dictionary Terms
What Are the Limitations of the P/S Ratio?
Since the P/S ratio doesn’t take earnings into account, it is not a good indicator of how profitable a company is or whether a company will ever become profitable in the future. In other words, what makes it useful for evaluating newer companies and companies in growth phases also makes it a somewhat limiting metric.
The P/S ratio also doesn’t take debt into account. One company could have a much lower ratio than another in its industry, but that same company could also have a large amount of debt, while its competitor might be debt-free.
As is the case with most other metrics, a company’s P/S ratio alone cannot enable an investor to make an educated decision to buy or sell a stock. It's essential to look at a number of fundamental factors—both quantitative and qualitative—when evaluating a company to gain a more holistic understanding of its financial and functional health.
Average P/S Ratios by Industry (Jan. 2021)
|Industry||Sample Size||Average P/S Ratio|
Auto & Truck
Brokerage & Investment Banking
Green and Renewable Energy
Hotels and Gaming
Investments and Asset Management
Publishing and Newspapers
Frequently Asked Questions (FAQ)
Below are answers to some of the most common questions investors ask about P/S ratios.
What Is a Good P/S Ratio?
“Good” P/S ratios vary by industry. While, as a general rule, ratios below 2 are typically considered healthy, and ratios below 1 are sometimes considered very good, a particular company’s ratio must be compared to those of its competitors and the average ratio for its industry (see table above) in order to determine how “good” it is in relative terms. For instance, given the data above, a P/S ratio of 2 might be considered low (good) for a restaurant chain, but the same ratio might be considered high (potentially bad) for a food wholesaler.
It is normal for companies in different industries to have different P/S ratios, so comparing the P/S ratio of a restaurant to that of a food wholesaler would be like comparing apples to oranges. A food wholesaler might have higher sales volume (and thus a lower ratio) but a smaller profit margin. A restaurant might have lower sales volume (and thus a higher ratio) but a larger profit margin. In other words, two companies could have identical earnings but different P/S ratios due to differences in their profit margins and sales volumes.
Is a High or Low P/S Ratio Better?
While most investors consider lower P/S ratios to be preferable, neither a high nor low P/S ratio is inherently better. A low ratio indicates that the market is willing to pay a relatively low price for each dollar of a company’s sales, which could be a good sign for investors hoping to identify and purchase undervalued stocks.
A high ratio, on the other hand, indicates that the market is willing to pay a relatively high price for each dollar of a company’s sales. This could mean that the company is overvalued, but it could also be a signal that investors and analysts see value in this company beyond its sales—perhaps it has a track record of consistent growth or a product offering that is unique in its industry.
Different industries have different norms, so comparing the P/S ratio of an airline to that of a clothing company would not provide meaningful information as to which company is in better shape or might be a better stock pick.
Value investors who prefer to target undervalued companies and see gradual returns over the long term might prefer stocks with lower P/S ratios than other stocks in a particular industry. Investors with higher risk tolerance who are looking for more substantial returns in the short term might put more weight on relevant news and market sentiment than valuation and thus might focus less on P/S ratios.
When Are P/S Ratios Most Useful?
P/S ratios are most useful for investors who want to compare the performance of two or more similar companies in the same industry, especially if those companies haven’t posted positive earnings over the last 12 months. Because this ratio compares stock price to sales instead of profit, it is often used to compare newer companies in a particular sector or industry that have yet to make a profit or more established companies in an industry that hasn’t seen profit over the past 12 months due to economic cycles.
Taking a company’s P/S ratio into account can also be helpful any time you are considering adding it to (or removing it from) your portfolio. However, it is important to remember that metrics like this are most valuable when viewed alongside qualitative factors (like competitive advantage, management skill, etc.) and other quantitative metrics (like debt-to-equity ratio, free cash flow, etc.), as no one number or piece of information can tell an investor everything they need to know about a company’s value.
Do Cryptocurrencies Have P/S Ratios?
Some crypto investors do use a form of the P/S ratio to evaluate crypto projects. Much like stock investors use P/S ratios to value newer companies or those in growth phases that have yet to report earnings, crypto investors may use a similar ratio to evaluate projects and protocols in the DeFi (decentralized finance) market, as most are still relatively new, and the crypto landscape is evolving rapidly.
The ratio is calculated in the same way (i.e., market cap is divided by 12-month trailing revenue). In the crypto sphere, “12-month-trailing revenue” generally means the total fees paid by a blockchain’s users over the course of the past year. Crypto projects with lower ratios may be considered undervalued by some investors, but the crypto market is still relatively new and unpredictable, so metrics like this should be handled with caution.