Investors use various key ratios as a way to determine the value of a company. The most common one is the price-to-earnings, or P/E, ratio.
Value investors often use the P/E ratio to determine if a stock is cheap. The lower the ratio the cheaper the company.
However, the P/E ratio has its flaws. It is easier to manipulate earnings than other aspects of a company's performance. That's why I like to also use the price-to-sales, or P/S, ratio when I'm looking for top value stocks.
What Is The P/S Ratio?
The P/S ratio uses the market capitalization of a company and divides it by the past 12 months' revenues. A low price-to-sales ratio is preferred as that means an investor is paying less for each sale.
It is more difficult for a company to tweak sales performance, than it is to influence earnings, since it's pretty straightforward. A sale is a sale. It's harder for a company to move money around and produce it. Therefore, the P/S ratio can be a better indicator of hidden value than the P/E ratio.