Why Market Cap To Sales Ratio Is An Important Indicator For Buying Shares?

Investors use various parameters to gauge the performance of a company. Among these price to earnings ratio, price to book value etc., are important indicators. However, market cap to sales ratio can also be considered important for buying shares.

What is market cap to sales ratio?

It is also known as sales to price ratio and helps investors to understand how the market is pricing every rupee sale of the company.

How this data is useful is often an important question. While valuation is relative and what one individual feels is cheap, the other might feel is expensive. For example, one analyst might feel a p/e of 25 times is expensive, while another might feel it is cheap. In terms of market cap to sales ratio, anything under 1 is considered as cheap and anything over 1 is considered as expensive.

Let is understand this with an example: Say the market cap of a company is Rs 1000 crores and the sales is Rs 1500 crores.

So, market cap to sales would be as follows = Rs 1000 crores/Rs 1500 crores = 66.67

What this implies is that for every sale of Re 1, you are willing to pay a price of 0.67 paise. This is a very important indicator and hence market cap to sales ratio is being increasingly used.

The other reason for using this indicator is that things like EPS etc., are derived from net profits which can be easily manipulated by increasing or decreasing costs. It is much more difficult to manipulate sales.

Another important reason for considering market cap to sale ratio is that it enables you to quickly spot the change in direction of sales.

As mentioned earlier it is important to remember that any ratio below 1, is considered as relatively better. Anything over 1, means you are ready to pay a higher price and that would again depend on the future outlook any expansion plan that may add to sales etc.

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