← Back to Learn Investing

The Price-to-Sales Ratio: Valuing Companies With No Profits (Yet)

Valuation • Beginner Investing • 7 min

What this lesson is about

When a company has no earnings, P/E can't be calculated at all. Price-to-sales steps in, using the one number almost every company actually has: revenue.

2 parts · a quick check after each · then the quiz

Part 1 of 2

Every, public, company, has, revenue., Even, one, that's, losing, money, hand, over, fist, usually, shows, a, positive, total, sales, figure., That, fact, makes, the, price-to-sales, ratio, useful, when, the, P/E, ratio, fails, completely., P/S, is, calculated, by, dividing, market, capitalization, by, total, annual, revenue., You, can, also, think, of, it, as, share, price, divided, by, revenue, per, share., In, contrast,, P/E, divides, price, by, earnings,, which, can, be, zero,, negative,, or, distorted, by, one-time, accounting, items., P/S, uses, a, number, that's, almost, always, reliable, and, harder, to, fake.

This, makes, P/S, the, go-to, metric, for, young,, fast-growing, companies., These, firms, often, spend, more, than, they, take, in, to, grow, market, share., Early-stage, software, companies,, biotech, firms, still, years, away, from, a, marketable, drug,, and, many, newly, public, companies, across, different, industries, have, been, valued, mainly, on, revenue, multiples, when, a, P/E, couldn't, be, calculated, at, all., Amazon, is, a, well-known, example:, for, years, after, its, mid-1990s, founding,, investors, focused, on, revenue, growth, and, multiples., Consistent, GAAP, profitability, didn’t, come, until, years, later.

What you pay for the earningsA multiple is a number of years of profit. Move it and see how many.

Quick check

How is the price-to-sales (P/S) ratio calculated?

Part 2 of 2

Insider, Angle:, Professionals, often, use, EV/Revenue, instead, of, plain, P/S, for, a, good, reason., Just, like, EV/EBITDA, is, preferred, over, P/E,, EV/Revenue, adjusts, for, debt, and, cash., This, way,, two, companies, with, the, same, sales, but, very, different, balance, sheets, aren’t, compared, unfairly., However,, both, versions, have, the, same, blind, spot:, a, very, low, P/S, isn't, automatically, a, bargain., Some, businesses,, like, grocery, retailers,, operate, on, razor-thin, margins, as, a, structural, fact,, not, a, temporary, discount., So,, a, low, P/S, in, that, case, can, simply, mean, "this, is, a, low-margin, business,", not, "this, is, cheap."
Try, This:, Find, a, young,, not-yet-profitable, public, company, you’re, curious, about., Calculate, its, P/S, ratio., Then,, find, one, established,, profitable, competitor, in, the, same, industry, and, calculate, its, P/S, too., Is, the, gap, between, them, due, to, growth, expectations,, margin, differences,, or, both?

Quick check

Why is the P/S ratio especially useful for young, fast-growing companies that aren't yet profitable?

Quiz

Master this lesson

Test what you just learned. Correct moves you up, wrong moves you down - reach 100 to master this lesson.

0
/ 100
Log in to save your progress and earn XP.

Related lessons

Swipe for more
Price-to-Book Ratio: Essential for Banks, Nearly Useless for Software The same ratio that's a core tool for valuing a bank tells you almost nothing useful about a company whose real assets never show up on its balance sheet. 7 min Intermediate EV/EBITDA: The Multiple Professionals Reach for First When two companies run the same operating business but carry different amounts of debt, P/E tells two different stories. EV/EBITDA is built specifically to tell one consistent story. 8 min Intermediate Valuation in a Rising vs. Falling Interest Rate Environment The same discount-rate math that values a bond explains why growth stocks get hit hardest when rates rise, and why they often rebound hardest when rates fall. 8 min Intermediate