• The P/E ratio is popular for stock valuation but not suitable for micro stocks
  • The Price/Sales or P/S ratio meanwhile is a better measure for these stocks
  • So what is the P/S ratio and how do we read the numbers?

 

The Price to Earnings (P/E) ratio is one of the most widely-used indicators employed by investors to assess a stock’s valuation.

But while the P/E ratio is popular, it might not be the best tool for evaluating early-stage companies.

This is because most early-stage stocks (or those considered micro stocks) may not have positive earnings or profits to show, making the P/E ratio irrelevant.

The Price-to-Sales (P/S) ratio therefore may be better than the P/E ratio in evaluating companies that are not yet profitable or have inconsistent earnings.

In short, the P/S ratio is the market cap of a company relative to the total amount of its annual sales:

 

Price/Sales Ratio = Market Cap / Total Sales over the past 12 months

 

Another reason the P/S ratio is a better measure than the P/E ratio for smaller-capped companies is because earnings tend to be more volatile than revenues at the smaller end of town.

P/S ratio captures top line revenues whereas P/E captures bottom line earnings, and because of that, P/S allows for more straightforward comparisons across companies with varying levels of profitability.

The P/S ratio is also often a better indicator for assessing growth potential of high-growth sectors (like tech stocks) where future profitability is expected but not yet realised.

Finally, in cyclical industries like construction or retail, where bottom line earnings or profits can swing wildly, the P/S ratio gives a steadier sense of a company’s worth.

 

What’s considered a good P/S ratio?

The P/S ratio essentially indicates how much investor equity is required to generate $1 of revenue, so you generally want to see a lower number here.

While the ideal ratio depends on the company and industry, the P/S ratio is typically good when the value is below 1.

Higher P/S ratios, on the other hand, may suggest that a company is not efficiently utilising investor funds to generate its revenue.

Big retailers like Coles (ASX:COL) and Woolworths (ASX:WOW) traditionally have some of the lowest P/S ratios on the ASX because they have huge sales volumes but relatively low profit margins.

Energy retailers also often have low P/S ratios for the same reason.

 

Here’s the top 10 large caps with the best P/S ratios on the ASX:

Data from Commsec:

Wordpress Table Plugin

 

Here’s the top 20 small caps with the best P/S ratios on the ASX:

Data from Commsec:

Wordpress Table Plugin

 

Marley Spoon (ASX:MMM)

Marley is a subscription-based weekly meal kit service that services customers in Australia, United States and Europe.

The company’s latest quarter release showed that for Q1 2024, net revenue came in €80.7m, up nearly 10% quarter-over-quarter.

“After a challenging 2023, 2024 started with a stabilization of our customer base, resulting in quarter-over-quarter net revenue growth,” said Marley Spoon’s CEO Fabian Siegel.

 

Melodiol Global Health (ASX:ME1)

Melodiol develops cannabis, hemp-derived and other plant based therapeutic, nutraceutical, and lifestyle products with wide consumer reach.

In the latest trading update, the company said its Canadian subsidiary Mernova continued to make strong progress, launching additional products across various Canadian provinces

Mernova has received purchase orders of $1.3 million in a strong start to Q2 FY24.

Mighty Craft (ASX:MCL)

Mighty is a a craft beer accelerator with a nationally diversified portfolio of craft beverages.

It has built an infrastructure and distribution offering that enables the cpmpany to scale production, distribution, and sales as it seeks to become Australia’s craft beverage Company.

Recently, Mighty sold 7.5% of the shares in Better Beer to PURE Asset Management for approximately $6.1 million, as parts of its plan to reduce debt.

 

Beston Global Food Company (ASX:BFC)

South Australian-based BFC is the largest company in the Australian dairy industry outside of the multinationals, and is the seventh largest in Australia.

Beston has experienced its highest milk flows on record so far in FY24.

YTD milk intake from dairy farm supplier program at the end of Q3 was 124.2 mill litres, or 4.8 mill litres higher than forecast.

The higher than expected milk flows have occurred at a time when farmgate milk prices have been the highest on record for more than 30 years (and currently amongst the highest in the world).

 

At Stockhead we tell it like it is. While Melodiol Global Health is a Stockhead advertiser, it did not sponsor this article. 

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