A History of The Price-to-Sales Ratio

Price-to-sales is a very simple ratio. Arguably, it is the least nuanced and therefore least manipulated valuation measure. A sale, for the most part, is a sale. Unlike earnings, book value, and other fundamental measures which are sometimes more opinion than fact, sales is a more straightforward number. To be fair, there are still issues like aggressive revenue-recognition and channel stuffing that can be used to manipulate sales numbers (one of the joys of public markets is the felt need to constantly satisfy shareholders with strong quarterly results). Let’s see how the market has valued sales historically. First, here are the raw sales and sales growth for all U.S. stocks since 1963, and the price-to-sales for the overall market.

sales growth (dollars and 3 year rate)
market psr

Just as we saw with the price-to-book ratio, there are large average differences in the price-to-sales ratio across sectors.

psr by sector psr table

You’ll notice that higher margin businesses tend to trade at higher price-to-sales multiples. Which brings us to two important quirks about the p/sales ratio: margins and leverage.

First, If you sort all large stocks into five buckets based on their price-to-sales, and then calculate the total net margin for each bucket (total income/ total sales), you see a clear trend: higher price-to-sales = higher average margins, and lower price-to-sales = lower average margins.

net margin psr

A second quirk is that companies with more debt (high debt/equity ratios) tend to trade a cheaper multiples of sales, whereas those with little or no debt tend to look more expensive (as their sales are being generated with less borrowed capital).

psr by leverageThe easiest way to adjust for a companies use of debt is to instead use the Sales/Enterprise Value ratio (which adds debt to market cap in the denominator). We will explore that metric in the next post on using the price-to-sales ratio. You can’t really adjust for margin, as a “margin-adjusted” p/sales is just a price-to-earnings ratio!

Finally, we see a similar trend in the spread between cheap and expensive stocks using the p/sales measure as we did with price-to-book.

price to sales spreads

As we will see in future posts, price-to-sales is a great metric to use in combination with other valuation ratios. As a standalone measure, it has the advantage of being quite simple. You can use it to value stocks with negative earnings and cash flow (usually young, growth stocks). Just be mindful that stocks with low price-to-sales may only be cheap because of very low margins or because of very high debt levels.