Price to Sales Ratio
The financial metric known as the price to sales ratio, or PSR, tells the analyst or investor the cost to acquire $1.00 of the company’s revenues. The price to sales ratio only requires two inputs: the current market price of common stock and the company’s annual revenues.
Price to Sales = Market Value per Share / Annual Revenues per Share
- Annual Revenues per Share = Revenues / Shares of Common Stock Outstanding
The price to sales ratio is a high-level measure of the investment quality of a company. The use of this measure is relatively new, and became an important valuation indicator when startup companies were not generating profits but had significant revenues during the Internet Dot Com boom. Revenues per share were calculated since these companies had not yet generated profits, making the calculation of earnings per share impossible.
The use of revenues can be misleading, since they are not a guarantee of the longer term profitability of a company. As is the case with price to earnings ratios, a relatively high PSR is often seen when companies are expected to grow in the near term, while companies with lower growth prospects will usually have a lower PSR.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Company A’s current market price per share of common stock is $88.24. Company A’s income statement indicates total revenues of $29,611,000 and the company has 693,000 shares of common stock outstanding. The price to sales ratio of Company A would be:
= $88.24 / ($29,611,000 / 693,000) = $88.24 / $42.73, or 2.07