price-to-sales ratio
A valuation metric comparing a company's stock price to its revenues, calculated by dividing market capitalization by annual revenue. Useful for unprofitable companies.
Example
“With a P/S ratio of 2, investors were paying $2 for every $1 of annual revenue — cheaper than competitors at 5x.”
Memory Tip
P/S ratio = how much per dollar of sales. Useful when companies aren't profitable yet.
Why It Matters
The price-to-sales ratio helps you evaluate whether a company is overpriced or underpriced relative to the money it actually brings in, which is especially valuable when researching stocks of companies that are not yet profitable. This metric can protect you from investing in companies that are burning cash while their stock price soars, making it a useful reality check before putting your money into a business.
Common Misconception
Many investors wrongly believe that a low price-to-sales ratio always means a stock is cheap and a good buy, but this ignores the quality of those sales and whether the company is actually moving toward profitability. A company with terrible profit margins or declining revenue could have a low ratio but still be a poor investment choice.
In Practice
Suppose Company A has a market capitalization of 5 billion dollars and annual revenues of 2 billion dollars, giving it a price-to-sales ratio of 2.5, while Company B has a market cap of 3 billion dollars on revenues of 1 billion dollars, resulting in a ratio of 3.0. An investor comparing these two unprofitable tech startups might view Company A as better valued, but would still need to examine whether Company A is losing less money per sale than Company B before making a final decision.
Etymology
PRICE (market valuation) TO (divided by) SALES (revenue). Market PRICE relative to SALES.
Common Misspellings
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