Home / News / 2022 marks the end of the price-to-sales ratio

2022 marks the end of the price-to-sales ratio

Price-to-sales ratios were viewed as something of a badge of honour by many in the venture capital and technology sector in 2020 and beyond. While those intricately involved in the sector couldn't predict the future, the sheer number and successful listing of hundreds of tech unicorns in 2020 and 2021 may well have marked the end of this valuation measure.
News

Price-to-sales ratios were viewed as something of a badge of honour by many in the venture capital and technology sector in 2020 and beyond. While those intricately involved in the sector couldn’t predict the future, the sheer number and successful listing of hundreds of tech unicorns in 2020 and 2021 may well have marked the end of this valuation measure.

The ratio is quite simple to calculate; what is more difficult to understand is its usefulness. Price-to-sales is assessed by dividing the market value of a company per share by its trailing 12-month revenue per share, or sales. As the name suggests, you are measuring how much you are paying for every dollar of revenue from a business.

This compares to say a price-earnings ratio, which compares the price to the most recent earnings or profits delivered by the business. An important distinction must be made here, which is that you the price-to-sales ratio is only measuring a single part of any business model, it gives no consideration to borrowings, expenses, interest, and the like.

  • It was made popular by the technology sector during 2020 and perhaps long before this by the likes of Amazon, which had prioritised growing revenue (and cash flow) over delivering a bottom-line profit to shareholders. Essentially, the key reason for using this valuation approach is because the companies being valued are “pre-profit,” that is, they are yet to (and possibly unlikely to) produce a profit in the foreseeable future.

    This has always been common in the technology sector, with companies, for example Facebook and Twitter, seeking to win significant market share but knowingly losing money to achieve this, because they were seeking to monetise this dominance once in a monopolistic position. The issue, as we now know, is that it became too commonplace, and shareholders learned that they were subsidising users of services like Uber, Airbnb and We Work.

    In the midst of the pandemic recovery companies like Snowflake were listed on price-to-sales ratios that exceeded 100 times. This is all well and good if you are able to convert these sales into profit, which tech companies can, eventually; the issue, however, is what happens when the cost of capital increases and profitability moves further into the future? We have now seen how the market reacts to that question.

    While the massive price-to-sales ratios of 2020 may never be seen again, the ratio still has some uses, particularly in industries where earnings are highly cyclical and massive amounts of investment is made in research and development. Once such sector is semiconductors, where price-to-sales can offer a look through the cycle at historical valuations.




    Print Article

    Related
    Older generations increasingly picking up the financial tab: Report

    The Productivity Commission estimated $3.5 trillion will pass on to future generations over the next 25 years, with this report illustrating just how that’s playing out now in families across Australia.

    Nicholas Way | 9th Oct 2024 | More
    Research report lashes media for failing older Australians

    An Australian Human Rights Commission study released this week is highly critical of the fourth estate for its coverage of ageing issues, citing a disproportionate focus on tensions between older and younger generations around wealth and finance as one obvious example.

    Nicholas Way | 2nd Oct 2024 | More
    Retirees can rest easy – the children are not after the family jewels

    New AMP research questions the assumption that the younger generation is anxiously waiting to inherit from their retired parents. Instead, they are looking to forge their own financial futures.

    Nicholas Way | 31st Jul 2024 | More
    Popular