Not every company has a track record. Everyone has to start somewhere though and even if you come across a company that has no track record at all because it is new, you may still be tempted to invest in it. Every major brand and company you can think of started out like this, and you probably wish you had invested in them to begin with as well.
There is something you can do to help you figure out whether these new prospects are worth considering though. It is called the price to sales ratio, and it uses the market cap of the company and the revenue to work out how promising it is.
Let’s say for example that we have a company which has a market cap of $ 4 million and revenue of $ 2 million. This would make its price to sales ratio 2, which is obtained by dividing the first figure by the second one. In another example a market cap of $ 5 million and revenue of $ 4 million would produce a price to sales ratio of 1.25.
Now these figures alone don’t tell you much. But they do tell you which company is priced more cheaply. In this case it would be the second company. You need to bear this in mind if you are looking for the best company to invest in. Cheaper companies can be underpriced or cheaper for a reason – perhaps because they are not performing as well and not valued as highly by investors.
You can see that you need to use this piece of information in conjunction with other sources of information in order to make a decision about any stock. And you should steer clear of using the price to sales ratio on a regular basis anyway.
It is good for using when a company is very young and has little to no track record in terms of sales. The most common example given concerns the companies that were huge during the dot com boom – many of these had nothing to show for their business at all. Working out the price to sales ratio before investing in them may have saved a lot of people a lot of money.
So you see it is important to consider all aspects of stocks before you decide which ones to invest in. The price to sales ratio is very important in helping you make that decision.
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