Abstract
The price-to-earnings (P/E) ratio is a key financial metric used to assess a firm's value by comparing its stock price to earnings. However, the P/E ratio becomes ineffective for firms with losses (Joos & Plesko, 2005). In such cases, the price-to-sales (P/S) ratio is an alternative valuation metric. However, while the P/S ratio helps compare firms with similar business models, financial leverage can distort the interpretation of the P/S ratio, potentially misleading investors. This study offers practical guidance for accounting and finance professionals on enhancing the utility of the P/S ratio by considering leverage effects. Using 147,951 firm-year observations from 2000 to 2022, we demonstrate when and how leverage significantly affects the explanatory power of sales-based valuation metrics. We also assess the usefulness of the enterprise value-to-sales (EV/S) ratio as a partial adjustment for leverage. Our findings suggest that the practical application of the P/S ratio requires careful consideration of firms’ capital structures. This paper contributes to practice by refining the interpretation of commonly used metrics in the context of loss-making and highly leveraged firms.
Recommended Citation
Lee, B. Brian; Shin, Haeyoung; and Kim, Dong-Kyoon
(2025)
"Valuing Firms Using the Price-to-Sales Ratio: A Practical Perspective,"
Southwestern Business Administration Journal: Vol. 22:
Iss.
1, Article 4.
Available at:
https://digitalscholarship.tsu.edu/sbaj/vol22/iss1/4
Included in
Accounting Commons, Business Administration, Management, and Operations Commons, Entrepreneurial and Small Business Operations Commons, Finance and Financial Management Commons