Course 402: Using Ratios and Multiples
The Drawbacks of P/S
In this course
1 Introduction
2 Price/Sales (P/S)
3 The Drawbacks of P/S
4 Price/Book (P/B)
5 Price/Earnings (P/E)
6 Price/Earnings: The Drawbacks
7 Price/Earnings Growth (PEG)
8 Yield-Based Valuation Models
9 Dividend Yield
10 Cash Return
11 The Bottom Line

Despite several advantages, the P/S ratio has some limitations. One major flaw is that sales may be worth a little or a lot, depending on a company's profitability. If a company is posting billions in sales, but it is losing money on every transaction, we would have a hard time pinning an appropriate P/S ratio on the shares because we have no idea what level of profits (if any) the company will generate.

We will reiterate that when using the P/S ratio, it is important to keep in mind that a dollar of earnings has the same value regardless of the level of sales needed to create that dollar. A dollar of sales at a highly profitable firm is therefore worth more than a dollar of sales for a company with a narrower profit margin. Thus, the P/S ratio is generally useful only when comparing firms within an industry or industries with similar profitability levels, or when looking at a single firm over time.

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