Price to Sales Ratio

Price to Sales Ratio

This article aims at helping you understand the definition and the formula of price to sales ratio. Have a look...
There are various techniques to research about the profitability of a firm. Identifying profit-making firms is very vital because only these firms in the stock market can give us decent returns on our investment. The earnings per share ratio, and price to earnings ratio are some of the most common ratios which are taken into consideration to judge the profit-making ability of a company. However, by comparing the price to sales ratio by industry estimates, we can take a call on whether stock investing or stock trading in a particular company would be advantageous or not.

Why Calculate It?

This helps us to know what market capitalization a company is enjoying in the stock market as compared to the total revenue generated by it in the last twelve months. If there is a positive sentiment in the market, it is observed that stock prices start increasing without considering the fundamentals of the stocks. So, along with fundamentally strong stocks, the weak stocks also rally along. This makes their valuations very expensive, and makes them vulnerable to a steep fall once the market changes its track. As a smart investor or trader, it is essential to invest in a cheap stock which has room for further appreciation in price, rather than a very expensive stock which cannot rise further. A high ratio can be an alarming sign for investors, and can also be a reason to quit the stock holding immediately. Many experts prefer to use the price to earnings ratio as well as price to sales ratio for stock research, instead of the earnings per share ratio to determine the real worth of a company.

How to Compute It?

Price to Sales Ratio = Market Cap of the Company ÷ Revenue Per Share Generated.

This ratio will help you understand how much market capitalization a company is receiving for the sale generated by it. The lower the market capitalization of the company as compared to the sales figures of other companies, the better it is for investment purposes. This means that you should avoid investing in stocks having a high market capitalization for a very small sale. These stocks might have gone up just because of technical reasons or bulk purchases from big investors, and are not safe bets for retail investors.

Now, let us see how to calculate market capitalization of the company. The market value of equity or the market capitalization is given by the following formula.

Market Capitalization = Share Price × No of Outstanding Shares.

In this formula, there are two important components - the share price and the number of outstanding shares. The fact is that both these components change frequently, and hence, you can take an average of them to arrive at the market capitalization. The value of market capitalization obtained can be substituted in the above formula to find out the price to sales ratio.

Hopefully, this content will enable you to choose the right kind of stocks and earn a good amount of money through trading stocks and dividends. So, get out your calculators and start investing smartly. All the best!