The use of ratios to determine value stocks is not new in the investment world. Among the ratios generally used, Price-to-Sales has surfaced as an important tool to determine the value of stocks that are suffering losses or are in the early cycle of development, generating little or no profits.  

Though a loss-making company tends to lose investor attention with a negative Price-to-Earnings ratio, its Price-to-Sales could indicate the hidden strength in its business. This underrated ratio is also used to identify recovery situations or to ensure that a company’s growth is not overvalued.

Price-to-Sales is often preferred over Price-to-Earnings, as a company’s earnings are subject to accounting estimates and management manipulation but its sales figures are assumed to be relatively reliable.

A stock’s Price-to-Sales ratio reflects how much investors are paying for each dollar of revenues generated by the company.

If the Price-to-Sales ratio is 1, it means that investors are paying $1 for every $1 of revenues generated by the company. So it goes without saying that a stock with Price-to-Sales below 1 is a good bargain, as investors need to pay less than a dollar for a dollar’s worth. 

In terms of comparison, a stock with a lower Price-to-Sales ratio is more suitable for investment versus a stock with a high Price-to-Sales ratio.

However, one should keep in mind that a company with high debt and a low Price-to-Sales metric is not an ideal choice. The high debt level will have to be paid off at some point, leading to further share issuance and a rise in market cap and ultimately the Price-to-Sales ratio.

In any case, the Price-to-Sales ratio used in isolation can’t do the trick. One should also analyze other ratios like Price/Earnings, Price/Book, Debt/Equity before arriving at any investment decision.

Screening Parameters

Price to Sales less than X Industry Median: The lower the Price-to-Sales ratio, the better.