Price to Sales
When earnings are negative, earnings multiples cannot be calculated. Price to sales fills the gap, but it is the crudest of the common multiples.
Why this matters for beginners
Unprofitable companies are often valued on revenue alone. Understanding what the multiple hides prevents paying a premium for revenue that may never become profit.
Main explanation
Price to sales divides market value by annual revenue. It works for loss-making companies because revenue is almost always positive.
Its weakness is that it ignores margins entirely. A low-margin distributor and a high-margin software company cannot be compared on this basis.
A partial fix is to relate the multiple to gross profit rather than revenue, since gross profit reflects the actual economics of each sale.
The multiple is best used within a single industry and alongside a view of what margins the business could plausibly reach at scale.
Example using a real company
Two companies each have 200 of revenue. One has 80 percent gross margins and the other 20 percent. Identical price to sales multiples imply very different value.
- →Market value 1,000 on revenue 200: price to sales of 5.
- →The same multiple on 20 percent gross margins implies a much higher price against gross profit.
Common beginner mistakes
- ✕Comparing price to sales across different margin structures.
- ✕Treating revenue growth as equivalent to future profit.
- ✕Forgetting that debt is excluded from a market value multiple.
Key terms
- Price to sales
- Market value divided by annual revenue.
- Gross profit multiple
- Value compared against gross profit rather than revenue.
- Margin structure
- The profitability pattern of a business model.
Key takeaways
- 01Price to sales works when earnings are negative.
- 02It ignores margins, so comparisons must stay within an industry.
- 03Gross profit gives a more meaningful denominator.
Check yourself
- 01Price to sales can be calculated for a loss-making company.
- 02Price to sales accounts for differences in profit margins.
- 03Using gross profit instead of revenue improves the comparison.
Try the concept on a real company
Compare a high-margin software company with a low-margin retailer in the Analyzer and note how misleading a shared sales multiple would be.
Educational examples only. Not buy or sell recommendations.