Price to Sales Ratio (PSR) Explanation
There are many tools you can use in order to valuate a stock. One of them is the price/sales ratio (PSR). Many experts have proven that stocks that enjoy low PSR have managed to do better than stocks that are characterized with low P/E multiples. PSR represents a more reliable tool for valuating stocks since many investors consider P/E as susceptible to manipulations. However, managers can hardly manipulate the sales that the company has made during a particular time period. PSR is preferred by investors also because the wide use of the Internet has led to the preference of stocks that present higher potential for growth, instead of a focus on the earnings which they generate.
In order to calculate a company's price/sales ratio you should divide the price of the company's stock by its sales. However, you can hardly find information of the sales of a company in per-share figures. Thus, the total market value of the company is usually divided by the total sales of the company that it has made for the past one year.
You should look for companies that have a PSR of less than 1. A lower PSR may mean that you are able to purchase a particular amount of its sales cheaply. However, the lower price of the company may be due to some fundamental reasons, which in the future may lead you to losing money. However, the market may have just overlooked the company and it is your turn to pay attention to it and take advantage of the moment.
Some financial investors claim that PSR is best applied for large cap companies. This is explained by the fact that such companies most closely manage to keep up the large sales they generate. Other financial experts claim that PSRs are hardly applicable for service companies because they don't make any sales but instead provide different types of services.
Finally, when you apply PSR you should use it to make comparisons between the company and its competitors as well as its peers from the same industry.
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