Price-to-sales ratio: valuing companies without profits

The price-to-sales ratio compares what the market values a company at with the revenue it generates. It is mainly used when earnings are negative, tiny or temporarily depressed, because a P/E ratio cannot be used in those cases. It is a blunt tool, since revenue says nothing about how much of each sales dollar turns into profit, so it needs to be read alongside margins.

The formula

P/S = market capitalization / revenue (last 12 months)
    = share price / revenue per share

EV/Sales = enterprise value / revenue

Revenue is also called sales. Market capitalization is the share price times shares outstanding; see market capitalization for the details. Some analysts prefer EV/Sales because revenue belongs to all providers of capital, not only shareholders, so the numerator should include debt as well. See enterprise value for how that is built.

Why people use it

• It works when earnings do not. A growing company may deliberately report a loss while it invests. P/S still gives a number.
• Revenue is usually more stable than profit. It sits at the top of the income statement, before most accounting choices and one-off charges.
• It is harder to distort, though not impossible. Revenue recognition rules leave some room for judgment; see revenue and revenue recognition.

The link between P/S and P/E

The most useful thing to know about P/S is how it connects to the P/E ratio through the net profit margin:

P/S = P/E x net profit margin
P/E = P/S / net profit margin

Net margin is net income divided by revenue; see gross, operating and net margin.

Example (illustrative numbers)

Two companies each have a P/S of 4.

The same P/S means very different things. For A, each dollar of sales yields 20 cents of profit, so the price is 20 times earnings. For B, each dollar of sales yields 5 cents, so the same price is 80 times earnings. B would need its margins to improve a lot, or its sales to grow a lot, before its price looks reasonable on profit. This is the single most important reason not to read P/S in isolation.

How to read it

Rules of thumb:

• Compare like with like. P/S ranges differ enormously between industries. A grocery chain, with thin margins, naturally has a low P/S. A software company with high gross margins naturally has a higher one. Compare companies in the same sector with similar margin structures.
• Look at margin and its trend. A high P/S is only sustainable if the business can earn healthy margins at scale. Ask what margin the company could plausibly reach and what the P/E would be then.
• Look at growth. Faster revenue growth can justify a higher P/S, but only if growth is durable and eventually profitable. For subscription software specifically, see the Rule of 40 and SaaS metrics.
• Use gross margin as a cross-check. If gross margin is low, there is little room for operating costs to leave a profit.

Common mistakes and limits

• Ignoring profitability. A low P/S is not cheap if the business cannot earn a profit. Revenue is only valuable to the extent it converts to cash for owners.
• Ignoring debt. Two firms with the same market cap and revenue can have different debt loads. EV/Sales corrects for this; P/S does not.
• Revenue quality. Recurring revenue, one-time sales and revenue booked gross versus net are not equivalent. A marketplace that reports total transaction value as sales will look different from one that reports only its commission. Increases in deferred revenue can also signal future recognized sales.
• Acquired revenue. Revenue purchased through acquisitions is not the same as organic growth.
• Dilution. Companies paying heavily in stock can show strong sales growth while spreading ownership thinner.
• Using it as a stand-alone verdict. P/S is a starting point for questions, not an answer.

When it is most and least useful

P/S is most helpful for early-stage companies, cyclical companies at trough earnings, and businesses where margins are expected to normalize. It is least helpful for companies whose profitability is the main investment question, such as banks, where revenue is hard to define, or low-margin distributors, where a few points of margin change everything.

Key takeaways

• P/S is market cap divided by revenue; EV/Sales adds debt and subtracts cash for a capital-structure-neutral view.
• P/S equals P/E multiplied by net margin, so margins decide what a given P/S really costs.
• Compare within a sector and look at margin and growth together.
• A low P/S is not a bargain unless the revenue can eventually produce profit.