Man Measuring MoneyThere are literally thousands of ways investors can determine the merits of an equity investment.  Some investors rely on qualitative factors such as feel and emotion.  Those that use charts to identify historical patterns focus on technical analysis.  And still others usea company’s balance sheet and income statements to identify the fundamental reasons for making an investment.

One of the most intuitive and historically significant fundamental ratios is called the Price to Sales ratio (P/S).  In this case it is exactly what it sounds like.  We come to the ratio by dividing the price of the stock by the amount of sales per share generated by the company.   This information is readily available via Yahoo or Google Finance (or if you so choose directly from the company’s SEC filings).

Below I have two screenshots of Chevron’s (CVX) total revenue (i.e. sales) and the total shares outstanding (taken from Google Finance).  Revenue is found on the Income Statement and Shares Outstanding is found on the Balance Sheet.  Why do we need both?   We need to divide the total revenue by the shares outstanding for the period in question; this gives us the amount of sales per share (for 2012 it would be 241,909 / 1,946.70 = 124.27).  We can now take that number and divide the price per share (which as of 6/24/13 was near $117.89 which gives us a Price to Sales ratio of 0.95.  This can be calculated for either quarterly or full year data.So how do we use it?  Some investor’s favor P/S over Price to Earnings (P/E) because sales is a harder number for management to manipulate via accounting gimmicks.  If we calculate the P/S over a period of time we can see whether or not the current P/S is high or low relative to the company’s long-term averages.  A P/S near the top of the range might suggest a more expensive company while a lower one might suggest a company is undervalued.  We can also compare it to other companies to determine valuation relative to other investments.

Chart

Remember though, P/S is no different than any other tool.  It is just one item to use when trying to identify a good stock to buy.  To be a good investor you need to be disciplined and look at a variety of data points in order to make sound decisions.  There is no reason P/S shouldn’t be one of them but don’t base your decisions on it alone!

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