What Is A Price To Sales Ratio?

moneyA price-to-sales ratio is one way of valuing of a company. It compares the market value of a company with the total sales over a 12 month period. A low price-to-sales could suggest that investors may be undervaluing each dollar of sales that a company is making.

By itself a price-to-sales ratio, which is sometimes abbreviated to PSR, may not be very useful. However, it can help to compare the valuation of a company relative to others within the same industry.

A PSR may be useful when looking at companies in their early stages of development. This is when operating costs may overwhelm revenues, which would drive the company into loss. But just because the business is profit-less does not make it worthless. So the PSR can be used to gauge whether the market is overly pessimistic at valuing every dollar of revenue.

The PSR can also be useful when valuing companies that have suffered a temporary setback, which may cause it to be unprofitable. For instance, in an economic downturn, a business with high overheads may become unprofitable even though it is still generating sales. So a PSR might be a handy way to size up the company’s revenues relative to its peers. A low PSR may suggest that the business has been unvalued by the market.

A price-to-sales ratio has limitations because businesses ultimately need to make profits rather than just sales. That said, it can be a handy ratio when looking for undervalued businesses.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.