P/S – Price-to-Sales Ratio
What Is the P/S Ratio?
If a company's P/E ratio is negative, it can no longer be used for valuation – the price-to-sales ratio (P/S) provides a solution. Especially for new companies in their startup phase that do not yet generate profits, the P/S ratio is used for assessment, in order to still provide a meaningful statement for investors.
Calculation
| P/S < 1 | Very cheaply valued |
| P/S 1 – 2 | Fair valuation |
| P/S > 3 | Rather expensive valuation |
Use in the Finanzoo F-Score
In the Finanzoo F-Score, the P/S ratio is weighted at 15% – however, only when the P/E ratio is negative for the corresponding period. In all other cases, the P/E ratio takes precedence.
Discussion
For companies with cyclically fluctuating profit margins, the P/S ratio is often a more suitable valuation criterion than the pure P/E ratio. Especially in turnaround situations and for newly founded companies in a phase of startup losses, it provides a meaningful statement for potential investors.
Proponents of the P/S ratio argue that the profit shown in the balance sheet can in many cases be manipulated through accounting tricks. Following this argument, revenue would be a more reliable metric than pure balance sheet profit.
However, the P/S ratio completely ignores a company's profitability. For example, a stock with a P/S ratio of 2 can still be significantly cheaper than a stock with a P/S ratio of 1, if the first company permanently generates a more than double profit margin. High revenue alone says nothing about whether a company also operates profitably in the long term.
In addition, revenue can also be manipulated through accounting tricks, thereby distorting the P/S ratio.
During the dot-com boom of the late 1990s and early 2000s, the image of the P/S ratio suffered greatly: it was used to justify very high valuations of fundamentally unprofitable companies. After the bubble burst in 2001, the P/S ratio lost significant reputation as a valuation metric – nevertheless, many analysts still swear by this ratio.
Conclusion
The P/S ratio should never be considered in isolation. For the purposes of fundamental analysis, Finanzoo recommends always combining it with ROA, P/CF ratio and dividend yield.