Price to Sales Ratio
The trouble with the P/E ratio is that earnings is a complicated "bottom line" number, sometimes reflecting non-recurring events;
so many people look at sales revenue as a more reliable indicator of a company's size and growth.
The Price/Sales ratio, also called the "PSR", is a company's stock price divided by its annual sales per share.
Since P/S = P/E x (profit margin), you can find any of these quantities if you know the other two:
This calculator is telling you that for a "typical" company with a profit margin of 5%, a P/S of 1.0 is in the right ballpark because it corresponds to a P/E of 20.
One common way people abuse the Price/Sales ratio is by assuming that a PSR of 1.0 is right for all companies,
and then hunting for "bargains" selling at a PSR of 0.5 or less.
That simply doesn't work in general, since different industries have widely different profit margins, ranging from 2% for many discount retailers to 20% or more for some software companies;
so a P/S of 1.0 would be on the pricey side for the retailer, but extremely cheap for the software company.
A second problem with the PSR is that sales, unlike earnings, contains no information about a company's debt.
It's easy to find lots of companies with no profits and huge debt selling at a PSR of 0.1 or less.
Some of these are on the verge of bankruptcy; definitely not "bargains".
For more on the PSR, see Ken Fisher's book Super Stocks (a Peter Lynch-style book about stock picking, but with more emphasis on valuation),
and James O'Shaughnessy's What Works on Wall Street (a statistical study of how well different valuation measures have identified stocks that actually beat the market).
Enterprise Value to Revenue Ratio
EV/R is an improvement over P/S, because it accounts for debt.
The denominator, Revenue, is a synonym for Sales.
The numerator, Enterprise Value, is the value of the company as a going concern.
Adding the value of any non-profitable assets - in practice that generally means Cash - gives the Total Value of the company:
EV + Cash = Total Value
The market's idea of Total Value is the value assigned by all investors, both stock and bond:
Total Value = Market Capitalization + Debt
So, substituting, and solving for EV, gives:
EV = Market Capitalization + Debt - Cash
Comparing EV/R and P/S
In the special case of a company with no cash or debt, EV/R and P/S are equal.
In more typical cases, companies have more debt than cash, making EV/R bigger than P/S.
This means that when finding value stocks, looking for a low EV/S is a more conservative (and more accurate) method than looking for a low P/S.
(An exception would be a recently capitalized company with no debt and lots of cash.)
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