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PS Ratio - How It Works and How Investors Can Use It

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When it comes to the stock market, sometimes you might hear the term "PS ratio" mentioned. It refers to a fundamental analysis metric that is popular among active stock traders.

This article will explain what a PS ratio is and how investors might be able to benefit from using it.

 

What Exactly Is a PS Ratio?

PS ratio (or P/S ratio) stands for Price-to-Sales ratio. It's a fundamental valuation metric used in the stock market to evaluate a company's stock price relative to its sales.

It’s calculated by taking the current share price of a company's stock and dividing it by its sales per share.

The formula looks like this:

Here is a breakdown of the components of the calculation:

Current Share Price: This is simply the current price of the company’s stock at any given moment.

Sales Per Share: This takes the sales of the company over the last 12 months (as of the company's most recent quarterly financial report), and divides it by the total shares outstanding for the company. The company's sales (also known as revenues) can be found on its income statement, and the company's outstanding shares can be found on its balance sheet.

The calculation above is the classic way to compute a company's PS ratio. It's also referred to as a trailing PS ratio since it's looking at historical sales (actual sales).

Companies also project sales, and there is a metric called a forward PS ratio that uses projected sales as the basis for the calculation.

 

Why Does a PS Ratio Matter?

PS ratios can be seen as a metric to gauge how attractive the price of a stock is at any given time.

Revenues are a cornerstone of any company's financial health. Without sales, it's hard for a company to generate any incremental economic benefit for itself.

The PS ratio looks at a company's stock price and compares it to those sales.

A low PS ratio suggests that the stock price might be relatively discounted compared to the value of the sales it generates.

A high PS ratio suggests that the stock price might be relatively expensive compared to the value of the sales it generates.

The PS ratio is a popular metric among value investors, who typically look to "buy low" on solid established companies.

 

How Do You Find Stocks With Low PS Ratios?

You can find them by using our Low PS Ratio scanner. It's a free tool we offer here at Stock Market Guides. It uses our proprietary scanning technology to find stocks that have low PS ratios.

Here's how the scanner results look:

 

That tool ensures that you don't have to waste time flipping through stock profiles manually to find stocks with low PS ratios.

 

Limitations of the PS Ratio

As is often the case, making an investing decision based on a single metric without any context may not be effective. As helpful as the PS ratio might be, it has some limitations to consider.

 

Different industries have different typical PS ratios.

In terms of determining which PS ratios qualify as "low", it might be helpful to look at the PS ratios of others in the same sector.

Profitability is not accounted for.

A PS ratio does not account in any way for profitability. If the sales are not profitable, the company's sales may not be a good gauge of the company's value.

 

Example of a PS Ratio Investing Strategy

For this example of a PS ratio investing strategy, we're going to look for stocks with low PS ratios and plan to hold them for up to a year.

 

 

In particular, we'll look for stocks with a PS ratio below 2. That value is considered by many to reflect a low PS ratio, regardless of industry.

Our research suggests this simple strategy might have a track record of success.

 

Entry for the PS Ratio Investing Strategy

The entry for this PS Investing strategy will be as follows:

The entry criterion for our PS Ratio investing strategy is very simple.

Exit for the PS Ratio Investing Strategy

There are a lot of possibilities here for the exit.

For any given investing strategy, it can be helpful to define two different criteria for the exit: a profit target and a time limit.

Not everyone sets exit criteria for a long-term investment, and that's totally fine. Ultimately, you are in charge of your investments, and you can manage them any way you want. But for the purposes of this investing strategy example, we will define them:

 

1. Profit Target

We will set a profit target that would reflect a 40% gain if the position were to be sold at that price.

In other words, we will take the price we paid for the stock at entry, multiply it by 1.4 (which effectively adds 40%), and use that to set up a sell limit order as a profit target.

If the sell limit order gets filled before the time limit is reached, then our investment is complete, and we will have realized a 40% return on investment.

2. Time Limit

We will set the time limit as one year. If the stock has not hit the profit target within one year of the date of stock purchase, then we can close the trade manually at the stock's prevailing price.

 

How Well Do Low PS Ratio Investments Actually Work?

The idea of a low PS ratio investing strategy sounds nice to many people because it offers a clear, easy-to-understand way to find an investment idea.

But does it actually work? Can traders indeed generate profits from buying low PS ratio stocks?

That's exactly what our company can help answer for you, since our scanner technology has allowed us to do our own research on that precise question.

The answer is that investments based on low PS ratios are not always profitable, but for certain stocks they might indeed have a track record of success according to our backtest research.

Here is some data that shows how a proprietary low PS ratio investment strategy we created has performed historically according to backtests:

 

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Anyone who signs up for our stock scanner service will be able to see stocks that qualify for that trading strategy in real time.

 

Learning More About PS Ratios

You can contact us any time if you would like to ask any questions about PS ratios or anything else related to the stock market.