Price-to-Sales (P/S) Ratio Explained: Valuing Revenue

#What Is Price-to-Sales?

The price-to-sales ratio divides a company's market capitalization by its total revenue. Unlike P/E, it works even when a company has no earnings.

P/S Ratio = Market Cap ÷ Trailing 12-Month Revenue

Or equivalently: Stock Price ÷ Revenue Per Share

If a company has a $10 billion market cap and $2 billion in revenue, P/S = 5.0.

#Why P/S Exists

P/E ratios don't work for companies with negative or minimal earnings. Many high-growth companies reinvest aggressively, reporting losses despite strong revenue growth. P/S fills the gap:

• Amazon was unprofitable for years — P/S was the primary valuation metric
• SaaS companies often prioritize growth over profit in early stages
• Biotech/pharma may have revenue but no earnings pre-profitability

#P/S Benchmarks

Rule of thumb: P/S × Net Margin ≈ P/E. A company with 20% margins and P/S of 5 has an implied P/E of 25.

#Limitations of P/S

1. Ignores Profitability

A company with $10B revenue and 0% margins is very different from one with 30% margins. P/S treats them the same.

2. Revenue Quality Varies

$1 of recurring SaaS revenue is more valuable than $1 of one-time hardware sales. P/S doesn't distinguish.

3. Easily Inflated

Companies can grow revenue by selling at a loss, acquiring other companies, or booking revenue aggressively.

4. Poor for Capital-Intensive Businesses

If a company needs massive capex to generate revenue, low P/S may not mean cheap.

#How to Use P/S Effectively

1. 1Compare within sector — never compare a retailer's P/S to a SaaS company's P/S
2. 2Pair with margins — P/S × expected margins = implied P/E
3. 3Track the trend — rising P/S without accelerating growth = expensive
4. 4Use EV/Sales instead — Enterprise value (market cap + debt - cash) ÷ revenue accounts for capital structure

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