Price Revenue or Price-to-Sales Ratio - Stock Valuations, Investing in Stock Markets Video Lecture | Investing in Stock Markets - B Com

to some investors it's the king of
ratios to me it's more like the prince
okay the price to sales ratio is one of
the most useful ways to decide whether a
share is cheaper expensive and it's been
shown to be a good predictor of future
share price performance all right so
let's take a look at what the price
price to sales ratio is how you
calculate it why it's fans love it and
some of the downsides as well all right
okay so the price to sales ratio how
would you go about doing it one of its
great benefits is it's a nice simple
clean ratio to number crunch all you do
for the price to sales ratio is take the
market capitalization m cap of a firm
and divide by 12 month sales usually the
last 12 months sales okay now you can do
it on a total basis so market
capitalization is number of shares time
share price the equity value of the firm
over sales or you can calculate it per
share so you could do the current share
price divided by sales per share you
should get the same answer so for
example if you knew that the firm's
market capitalization was let's say 80
million in sterling and you know the
sales figure is a hundred million then
the price to sales ratio is point eight
ok mechanically that's how it's done
so what well studies have shown at the
famous book what works on Wall Street in
the mid-90s for example but where the
price to sales ratio is below one
subsequent share price performance is
normally strong okay well above 1 or
watch out all right you're looking at an
expensive stock so very simple and very
simple to interpret all right so that's
why many people it is one of the
strongest ratios help there but what
other advantages does it have how else
can you use it
well first off notice it uses a sales
figure rather than something like
earnings so the price to earnings ratio
would use an earnings figure and
earnings are easier
manipulate and play around with if your
directs to the company so fans say this
is a stronger ratio because it uses a
sales figure it's harder to play around
the sales bigger now you can debate
whether you use the sales figure from
the formal accounts last published or
whether you try and sort of use an
updated rolling 12 month figure that
incorporates the recent most up-to-date
quarterly or half yearly figures but
nonetheless sales is a little bit
trickier to manipulate so fans saying
only is it simple and straightforward to
calculate and interpret just based on a
number which is both vitally important
without sales a business really is
nothing and also is perhaps less subject
to accounting whims in the way that say
an earnings figure could be and it's
useful for firms that are growing very
quickly and may have little or no
earnings or the earnings are very
volatile okay if you have no earnings
figure you can't do a p/e ratio because
there's no e in effect or if earnings
are swinging around all over the place
you'll get brazier to meaningless or
difficult interpret results so what a
lot of people did and the reason the
price to sales ratio got itself a dodgy
reputation a while back was they say
great well actually use this as a
substitute that the e ratio it's what
we'll do when when the dot-com boom came
along and they say well there are
companies with no earnings what we'll do
is we'll substitute this for the p/e
ratio so you started to get some
ridiculous assumptions being made like
well the firm has a P s of 10 it's
cheaper than a firm the price to sales
ratio of 20 or 50 well in one sense
that's true but don't forget the studies
that done homework on the price to sales
ratio say a bargain is where the price
of sells ratios below 1 not below 10
below 20 so in the dot-com boom it got
kind of misapplied if you like and if
you've heard people say well watch out
for the price to sales ratio it's
probably because of that all right
that's no reason to dismiss it from
today's stock searches now is it perfect
no it suffers some drawbacks ok so I'm
not going to suggest in this video that
you go out and just replace what you're
doing before with one number the price
to sales ratio what are the drawbacks
well for
of all sales isn't profits are the other
day okay as Lord Sugar once said on the
apprentice you can take ten pound notes
and sell them the nine pound or you like
the last not a business it'll have
turnover okay but you're making their
money so you've got the look at earnings
at some point you can't simply assume
that because the firm's making sales
okay it will make you money all right so
there's criticism number one and chrism
number two would be the debt trap okay
what I mean by the debt trap is this
it's perfectly possible for a firm to
basically be generating decent sales but
for the market to be worried about it
maybe because it carries a lot of debt
alright and the problem is this ratio
doesn't explicitly reveal that in one
sense so you might think brilliant to
stock the low price to sales ratio but
the reason is the market is worried
frankly about debt repayments interest
free payments that act they might even
go bust
so you pile in on a price to sales ratio
point five all right and a few months
later in a worst case scenario the
phone's gone bust alright no one warned
you well that's the so-called debt trap
and one of the ways that you can correct
that if you like is to substitute the
market capitalization on top which only
really consider the equity value of the
firm with something called the
enterprise value now I actually cover
what is enterprise value in a video not
surprisingly entitled what is enterprise
value all right so do take a look at
that video if you want to know more but
just be aware that that debt trap can
exist and here's another problem okay
I personally wouldn't use the price to
sales ratio in certain sectors I
wouldn't use it on financial firms and
the reason is that the way they report
revenue is a little bit different to
other sectors okay suddenly work so well
I also wouldn't use this ratio and asset
intensive sectors so I wouldn't apply it
directly to investment trusts for
example or property investment companies
right there other ratios perhaps like
the price-to-book ratio which again I
cover in another video might be more
useful to an investor okay so
the message coming through from this
short video on the price to sales ratio
is this is a useful simple easy to
calculate easy to interpret ratio
potentially okay but like all ratios
used in isolation it can be dangerous
okay so my advice would be have the
price to sales ratio in your armory as
long as you apply it to the right sector
and I mentioned to where I wouldn't
apply it but do use it alongside other
valuation ratios and if you want to see
what some of those other valuation
ratios might be do take a look at my
video six ratios that every investor
should know okay and there I suggest a
sort of little mini portfolio of ratios
that you can apply to determine or
whether or not a stock is genuinely
cheap or expensive