Cogito

Price to Sales Ratio: Advantages, Disadvantages

Posted in CFA by qmarks on May 1, 2010

On my previous post, I discussed about the advantages and disadvantages of Price to  Book ratio. Now let’s look at the advantages and disadvantages of Price to Sales ratio

First, Advantages:

  • Since the sales revenue is always positive, the price to sales ratio is meaning ful even firm is in distress
  • Sales revenue is not as easy to manipulate or distory as EPS and book value, which are significantly affected by accounting conversation
  • P/S ratios is not as volatile as P/E multiple
  • For start-up companies P/S is an appropriate measure whereas the P/E may be misleading. It is also a valuable tool for cyclical or mature industries

Disadvantages

  • If firms made significant amount of sales on credit, that will inflate their Price to Sales ratio, but that does not necessarily indicate operating profits as measured by earnings and cash flow
  • Furthermore, analyst should be careful about the revenue recognition practices that can still distort sales forecast thus P/S ratio
  • P/S ratios can capture the sales part, but it can not capture the differences in cost structure across companies
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