Price to Sales Ratio: A Poor Indicator of Value
The price to sales ratio is a marginal valuation ratio at best. It is really an offshoot of an antiquated concept of valuing a business. In the past, one of the more common methods to value a business deal was to use a multiplier of sales. It is still used today by many organizations to value a book of business such as a property and casualty insurance agent or the entire firm. If an agent wants to retire, the agent sells his book of business based on a multiple of the revenue he generates. The idea is that the buyer will receive a return on future sales to compensate the buyer for the money paid to buy the book of business.
The price to sales ratio used with business ratios is similar. Simply stated, the price to sales ratio is the entire market value of the company (the price) as a function of revenue (sales). To illustrate, let’s look at some common price to sales ratios for various large companies traded in the market.
Name Capitalization Sales Ratio
Verizon $242B $131B 1.85
3M $124B $33B 3.76
Exxon Mobile $341B $279B 1.22
Target $42B $75B .56
Notice the wide latitude of results?
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