In this “What Is…?” series, we break down complex investing terms into simpler forms for beginner investors.
Right now, let’s understand more about the term “price-to-sales ratio”.
So, What Is Price-to-Sales Ratio?
The price-to-sales (P/S) ratio is used to measure the value of a company for each dollar of revenue earned.
The P/S ratio is a valuation metric generally used to value companies that are still loss-making.
Since such companies do not have positive earnings to speak of, we can’t use the price-to-earnings (P/E) ratio to value them.
Therefore, the P/S ratio comes in handy to value unprofitable, but high-growth companies.
One such example is CrowdStrike (NASDAQ: CRWD), which has a long growth runway due to its huge total addressable market.
But it’s investing extensively in things like sales and marketing to further grow its customer base. That, together with other operating expenses, has caused its earnings to go into negative territory.
In its 2020 annual report, it said that it expects “to continue to incur net losses for the foreseeable future as we continue to invest in our business, and our sales capabilities in particular, to address our large market opportunity”.
Therefore, the loss-making CrowdStrike may not necessarily be a “lousy” business to invest in. To value such a company, the P/S ratio would be helpful.
P/S Ratio Formula
The P/S ratio is calculated by taking a company’s market capitalisation (or stock price) and dividing it by its sales (or sales per share).
P/S Ratio= Market Capitalisation / Sales
The sales can come in two forms.
If the sales figure is for the last 12 months, this P/S ratio is known as the “trailing P/S”.
The trailing P/S ratio is the most common type of P/S ratio.
On the other hand, if the sales figure is projected 12 months into the future, the P/S ratio will be known as a “forward P/S”.
Calculating P/S Ratio
Let’s still use CrowdStrike as an example to calculate the P/S ratio.
At a share price of US$210.62, the company has a market capitalisation of US$46.06 billion. With a trailing revenue of US$761.6 million, CrowdStrike’s P/S ratio is 60x.
We can then compare CrowdStrike’s P/S ratio with its history or with its listed peers to determine if it’s cheap or expensive.
If CrowdStrike’s historical average P/S is way below 60x, it could mean it’s undervalued and vice versa.
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Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock. The writer may have a vested interest in the company mentioned.