The price/sales (P/S) ratio focuses on the topmost line of the income
statement. Sales, also called revenue, reflect the amount of money a
company receives before taking expenses into account. As a raw measure of
performance, sales won’t tell you as much as profits will. Companies can
spend heavily to boost sales, while inefficient operation squeezes little
income from that revenue. However, studies show that the P/S ratio is also
an effective predictor of future performance. Stocks that are cheap based on
P/S ratios tend to outperform more expensive stocks—not unlike the
relationship between performance and P/E ratio.
To calculate the P/S ratio, start with the numerator. You can collect sales
data on the same website where you grabbed the earnings numbers. Find
the link for the income statement and add up the sales for the last four
quarters. Multiply the stock’s price by the number of shares outstanding—
this will give you the stock-market value, or market capitalization. Divide
that number by total sales from the last four quarters to derive the P/S. Like
P/E ratios, you can then compare the performance of the company in
question with others in the industry. For example, Pfizer traded at 3.7 times
sales at the end of August 2013—pricier than Merck and Eli Lilly, but
cheaper than Bristol-Myers Squibb.
Here are some other issues to consider while analyzing a company’s P/S
ratio:
The ratio works for just about every company. While many firms post
negative earnings or cash flows, just about all of them have positive
sales. When no other ratios work, you can often turn to the P/S ratio for
help.
While sales vary from quarter to quarter and will certainly rise and fall
with economic cycles, they don’t usually fluctuate as much as other
statistics. For that reason, the P/S ratio makes sense for stocks in
industries sensitive to cycles, such as companies that sell industrial
goods, discretionary consumer products, or semiconductors.
Companies’ customers buy more during good times and less when their
own situations get dicey. Sales will ebb and flow with that demand, but
they generally hold up better than earnings or cash flows.
Accounting rules for sales offer less leeway than the rules for
calculating earnings. As such, the P/S ratio is less susceptible to
manipulation by accounting than is the P/E ratio.
Price/Sales Ratio.
