Price-to-Sales Ratio (P/S)

The P/S ratio is calculated by dividing market capitalization by annual revenue, or equivalently, share price by revenue per share.

For example, a company with a market capitalization of 3 billion and annual revenue of 1.5 billion has a P/S ratio of 2.

P/S is useful for valuing companies that are not yet profitable, such as young, fast-growing businesses, because price-to-earnings ratios cannot be used when earnings are negative. Revenue is also harder to manipulate through accounting choices than earnings.

Its major limitation is that it ignores profitability. A company with high sales but very thin or negative profit margins may not deserve a high P/S ratio. Two companies with the same revenue can have very different values if one earns a 25% margin and the other loses money. P/S also ignores debt, which is why some analysts prefer EV/Revenue. P/S ratios are most meaningful when comparing companies in the same industry with similar margins.