Valuation indicators (6/9)

The price/sales ratio

Less well known than the previous indicators, the price/sales ratio (price to sales in English) is the ratio between the price of a stock and the annual sales (or turnover/revenues) per share. It had its moment of glory thanks to James O'Shaughnessy who concluded in 'What works on Wall Street' that it was historically the best valuation ratio. Sales also have the advantage of being less subject to accounting manipulation than profits, as is also the case for book value.

As with book value, the big advantage of sales to value a company is their almost universal side. They work well for small as well as large structures. They also apply to new companies that do not yet produce profits or that encounter temporary difficulties, as is typically the case with cyclicals (in this case the PER is useless).

However, just as we have seen with the book value, there are also risks in focusing on sales alone. Sales do not always translate into profits. We can therefore come across a company that sells a lot, but at the same time increases its losses due to insufficient margins. It is therefore appropriate to take the analysis a little further, as we have already stipulated above with the book value.

Provided that the company's fundamentals are strong enough, the price-to-sales ratio can therefore provide a good buy signal. I particularly like to find companies with ratios below 1, and it's even better if they are smaller than 0.5. Sales have one last advantage. They provide not only a good buy signal, but also a good sell signal, when the ratio exceeds 3.