P/S Ratio: Net Margin
According to James O'Shaughnessy, the P/S ratio is "the king of the value factors" in his book What works Wall Street. Using the S&P's computer database, his book concludes that there are strategies that consistently work, but there are some strategies that don't work. No matter what strategies you use, according to Shaughnessy, "Low price to sales ratios beat the market more consistently than any other value ratio"
The Price to Sales Ratio is calculated by dividing the stock's current price for the each individual share divided by the Revenue per share of one year.
P/S = Share Price/Revenue Per Share
Real Life Example.
B Tech
There is a company named B Tech who had a net sale of 5 million dollars, and 500,000 shares. The current price of a share is 20 dollars.
Sales per Share = (5,000,000 dollars/500,000 shares) = 10
Price to Sales Ratio = 20/10 = 2
ABC company
Real Life Example.
B Tech
There is a company named B Tech who had a net sale of 5 million dollars, and 500,000 shares. The current price of a share is 20 dollars.
Sales per Share = (5,000,000 dollars/500,000 shares) = 10
Price to Sales Ratio = 20/10 = 2
ABC company
There is a company named ABC company who had a net sale of five million dollars, and 500,000shares. The stock is trading at 100 dollars
Sales per Share = (5,000,000/500,000) = 10
Price-to-Sales Ratio = 100/10 = 10
Investors in A are willing to pay $10 for $1 in sales, while investors in B tech are willing to only pay $2 for $1 in sales. This is why ABC looks more appealing than B Tech in terms of the P/S Ratio.
Why It Matters:
The P/S ratio is considered a relative valuation measure because it is only useful when it is compared to the P/S Ratio of other companies. It is important to note that the P/S ratio varies by every sector. For example, retail companies tend to have much higher P/S ratios than companies in the research sector. Therefore, when comparing P/S ratios, compare the companies in the same sector.
Another reason why I prefer the P/S ratio over all of the other ratios is the simple fact that it is reliable, and is harder to manipulate. The P/S ratio is quite a honest measure of a stock's worth because sales figures are considered to be concrete facts. On the other hand, other figures, such as earnings, can be manipulated by using different financial theorems.
This does not entail a manipulation-free P/S ratio. Always read the fine prints of the financial statements in order to understand the company's stance on defining "revenue". On of the accounting tricks companies use in order to attract investors is by recognizing revenue earlier than it should have. This leads to an inflated sale figure, which in turn drives up the P/S ratio.
P/S ratios can be used with almost every type of stock, but do not use this as your only financial ratio when determining the value or worth ofa stock. For example, Company A may have very high sales, but a low profit margin, indicating that it is not operating efficiently, although it has a very high P/S ratio.
This does not entail a manipulation-free P/S ratio. Always read the fine prints of the financial statements in order to understand the company's stance on defining "revenue". On of the accounting tricks companies use in order to attract investors is by recognizing revenue earlier than it should have. This leads to an inflated sale figure, which in turn drives up the P/S ratio.
P/S ratios can be used with almost every type of stock, but do not use this as your only financial ratio when determining the value or worth ofa stock. For example, Company A may have very high sales, but a low profit margin, indicating that it is not operating efficiently, although it has a very high P/S ratio.
Sum up: The P/S ratio varies across different sectors, so use this to compare companies that are in the same sector. Because it doesn't factor in the expenses or the debt into account, it isn't the most accurate, so use this as a resource with other ratios, like the P/E.
