• 3 min read
Price to Sales (P/S): Spot growth before everyone else
Find out if you're overpaying for a company's revenue.
Explainer
A stock's Price to Sales (P/S) tells you how much you're paying for each dollar of the company's revenue.
Generally speaking, a lower P/S ratio is better, but rapid revenue growth can make a high P/S ratio justified.
How to read P/S numbers
P/S numbers typically fall into five ranges:
- P/S below 1.0: Potentially undervalued (buy opportunity)
- P/S 1.0-3.0: Fair value range
- P/S 3.0-6.0: Reasonable value range
- P/S 6.0-15.0: Expensive
- P/S above 15.0: Very expensive
Formula
A P/S ratio is calculated by dividing a company's market capitalization by its total annual revenue.
Example
This example shows two companies where one trades at a lower P/S ratio (better value) while the other trades at a higher P/S ratio (more expensive relative to sales).
| Company | Market Cap | Annual Revenue | P/S Ratio |
|---|---|---|---|
| Company A (Expensive) | $500M | $100M | $500M ÷ $100M = 5.0 |
| Company B (Value) | $300M | $150M | $300M ÷ $150M = 2.0 |
Here's the key insight: Company B's P/S of 2.0 represents better value compared to Company A's P/S of 5.0. With Company B, you're paying less than half as much for each dollar of revenue.
In our example, Company B (P/S 2.0) offers better value, while Company A (P/S 5.0) appears expensive relative to its sales.
Why P/S provides clearer insight
P/S provides value because it focuses on top-line revenue rather than bottom-line earnings, which can be affected by various accounting choices.
- Earnings can be shifted between quarters
- Sales figures typically reflect actual business activity
- P/S shows the real growth story without accounting tricks.
When does P/S work best?
P/S is most effective for:
- Unprofitable companies with strong revenue growth
- Comparing companies within the same industry or sector
- Early-stage companies that reinvest all profits back into growth
- Cyclical businesses where earnings fluctuate but sales remain stable
Limitations
The P/S ratio is not a perfect solution. Important limitations to consider:
- P/S ignores profitability - high sales mean nothing without decent margins.
- P/S ratios vary dramatically by industry (tech companies often trade at 8+ while retailers typically stay under 1)
- It doesn't account for debt levels or financial health
- One-time revenue spikes can create misleading low P/S ratios
The bottom line
P/S ratio answers a critical question: "What am I paying for each dollar of revenue this company generates?"
Before dismissing a stock because it has no P/E ratio or seems "expensive," always check its P/S. You might discover that the unprofitable company with massive sales growth is actually a better value than the profitable company with stagnant revenue.
This approach helps you spot tomorrow's winners while they're still building revenue today.
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