P/S = [(E/S) (1-b) (1+g)] / (R_ce - g) Clealy, firms with a high profit margin will sell at a higher price-to-sales ratio than firms with a lower profit margin, but why is that so? How is sales per share related to profit margin? A stock with a profit margin of 10% but massive sales, might have a P/S which is much lower (due to the high sales per share) than a stock with a profit margin of 10% but with little sales whose P/S is extremely high (due to a tiny sales per share).
What does your profit margin signify? NI/Sales And Net income = Earnings - which thro other parts (DDM etc.) drives your price. So unless you are in a “bound” situation - if you having bigger Sales - you are more likely than not having bigger NI (Earnings) and hence a higher Price. If not - the DDM / and any other model is not valid. Does this make sense?
cpk, no I don’t agree that having bigger sales translates into bigger earnings, very often the two are not directly related. Another way of trying to explain this equation, is that for the same company (don’t compare two companies), if profit margin rises on same sales level, the price must go up, hence a higher P/S. That makes sense.
I was not comparing two companies. I was stating within the realms of the same company only. now while comparing two companies within the same industry - and you find that price and sales are mismatched - then you would go and try to see why…
yep I see what you’re saying, I just wanted to point out that you could see sales double yet profits falling, for same company.