Price/sales

Price/sales and market capitalisation/sales are the same ratio calculated in slightly different ways. It measures the share price against a company's sales. Price/sales can be useful when a company is loss making or its margins are uncharacteristically low.

Price/sales uses sales as a measure of size. It is in many ways a crude measure of size, but given that this ratio is used when many others can not be used at all, this is acceptable. The ratio is simple to define:

share price ÷(sales ÷no of shares in issue)

Or equivalently:

market cap ÷sales

Comparisons across sectors should probably not be made. The best comparisons using this ratio are with very similar companies in the same sector. EV/Sales is in many ways a better alternative as it strips out the effects of debt.

Sales based valuation ratios do have a place as they indicate what a company with (hopefully temporary) abnormal margins would be worth if its margins could be returned to normal. By abnormal, we would normally mean low or negative in circumstances in which investors would expect either a turnaround (i.e. a return to business as usual) or a take-over. The latter as companies that are not profitable enough for their size are obvious targets.

Before resorting to sales based valuations, investors should remember that some profit based valuation ratios (such as EV/EBITDA) may be positive when others (such as PE) are negative (and therefore not meaningful).

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