Price/Sales Ratio

The next strategy to use is to look at the price/sales ratio, also known as the PSR. This measures the value of a company’s stock compared to the revenue. A stock of a company that is having good revenue indicates the business is active.

You can analyze the Price/Sales Ratio by doing the following:

1. Find the total number of outstanding shares available.
2. Add the sales totals for each of the past twelve months.
3. Divide those sales totals by the number of shares.
4. Divide the current value of the share by the result of step 3.
5. This gives you the PSR based on the past twelve months of trading.

You could also replace the sales totals for the last twelve months with the sales for the ongoing fiscal year if you wish. That would give you a more immediate answer, although the total might not be all that different. Numbers for the current fiscal year could be utilized as a forecast. The measurement from the past twelve months is more analytical and focuses on what has been changing in the business.

When the PSR is low, it means that a stock is cheap. It has a low cost when compared with the revenues that company is earning. Therefore, getting in while the PSR is low is often recommended as a buy.

The most important part of the PSR is that it is all based on sales. It is harder for a business to alter its sales totals than it would be to adjust any estimates an accounting team might produce.

Sales totals are often stable and work through cycles that change over the course of the year. You might be able to predict how the PSR changes depending on how a company performs in the sales department and whether or not the sales totals are expected to change. This adds a basic sense of simplicity in deciding whether or not to invest in a business.

Review Many Businesses in the Same Sector

The best way to work with the PSR is to check on as many businesses within a sector as possible. This could give you an approximate idea of what a typical PSR might be in that field. This could include measuring three or four stocks in the tech sector, for example. A business with a low ratio, when compared with the entire market, could have an undervalued stock. That is, it is cheap for the money. Meanwhile, anything high in value might be more expensive than necessary. Significant differences might also suggest that individual businesses have their own strategies or plans for how they will grow or operate.