Price to Sales and Price to Book

Price to sales (P/S) and price to book (P/B) are two valuation ratios that work when earnings-based measures do not. P/S compares a company's market value with its revenue, which makes it useful for young or temporarily unprofitable companies. P/B compares market value with the accounting value of shareholders' equity, which is useful for banks, insurers and asset heavy businesses. Both are simple, but each can mislead if used without context.

Price to sales#

P/S = market capitalisation / annual revenue = price per share / revenue per share

When P/S is useful#

• Unprofitable growth companies where earnings are negative.
• Cyclical companies at a trough, when earnings are depressed but revenue gives a steadier base.
• Comparing companies in the same industry with similar margins.

The margin problem#

P/S ignores profitability. A company with a 30% profit margin deserves a far higher P/S than one with a 3% margin.

Because P/S uses market cap, it also ignores debt. EV/Sales, which includes debt, is often a better choice. See EV/EBITDA and EV/Sales.

Price to book#

P/B = market capitalisation / shareholders' equity = price per share / book value per share

When P/B is useful#

• Banks and insurers, whose assets and liabilities are mostly financial and recorded near market value.
• Asset heavy businesses such as real estate, shipping or industrial firms.
• Deep value screening: stocks trading below book value.

What P/B tells you#

P/B and return on equity#

P/B is closely linked to return on equity (ROE). A company that earns a high ROE should trade at a higher P/B, because each dollar of book value generates more profit.

P/B = P/E × ROE

Pitfalls of P/B#

• Intangibles are missing: software, brands and research built internally are not in book value, so asset light companies look expensive. See Goodwill and Intangible Assets.
• Buybacks shrink equity, raising P/B. See Buybacks.
• Write downs can suddenly reduce book value.
• Tangible book value (excluding goodwill and intangibles) is often more conservative.

P/B and the value factor#

Academic research by Eugene Fama and Kenneth French in the 1990s used book to market (the inverse of P/B) to define value stocks, which historically outperformed growth stocks over long periods. The value premium was weak for much of the 2010s, and some researchers argue book value has become less meaningful in an economy dominated by intangible assets. See Value Factor.

Frequently asked questions#

What is a good price to sales ratio?#

It depends on margins and growth; compare with peers in the same industry rather than using a single threshold.

What does a price to book ratio below 1 mean?#

The market values the company at less than its accounting net assets, which can signal undervaluation or that the assets are worth less than reported.

Which companies are best valued with P/B?#

Banks, insurers and asset heavy businesses whose balance sheets reflect their economic value reasonably well.

Next, learn about income from stocks in Free Cash Flow Yield and Dividend Yield.