Price-to-Sales Ratio (P/S Ratio) and Financial Fraud

In the previous article Price-to-Earnings Ratio (P/E Ratio) and Value Investing, we discussed the P/E Ratio. The article mentioned that the P/E Ratio can be manipulated through accounting methods, and in addition, it is not suitable for all companies at different stages. Therefore, this article will discuss another concept: the Price-to-Sales Ratio (P/S Ratio).

History of the Price-to-Sales Ratio (P/S Ratio)

We’ll start from the beginning to understand why this indicator was proposed and what problems it was designed to solve at the time.

In the early 1970s, the P/S Ratio was proposed and applied, with no specific person recorded as its originator in history. However, it is widely believed that the early popularization of this indicator was largely due to Kenneth Fisher, who published “Super Stocks” in 1984, in which he emphasized using the P/S Ratio to find undervalued small-cap growth stocks.

When it comes to small-cap growth stocks, there are some savvy arbitrage investors who specialize in trading these stocks to achieve extremely high returns. We will introduce these types of players in our subsequent articles.

What Issue Does the P/S Ratio Address?

The introduction of the P/S Ratio Mainly Addresses 3 Types of Issues:

Valuation challenges for companies with profitability difficulties or losses: Traditional valuation methods, such as the Price-to-Earnings (P/E) Ratio, cannot be applied when companies have insufficient profits or incur losses. Because the denominator (earnings) is negative or too small, the P/E Ratio becomes meaningless. Many startups, high-growth companies, and enterprises in industry downturns often face profitability challenges, yet these companies may possess significant growth potential. Revenue growth often indicates a company’s future development potential, and the Price-to-Sales (P/S) Ratio can help investors identify companies with high growth potential.
Difficult to compare companies across different industries: Profitability and accounting practices can vary significantly across different industries, making the P/E Ratio less comparable between them. For example, profit margins in the technology sector may be higher than in traditional manufacturing, and directly comparing their price-to-earnings ratios could be misleading. Revenue, however, is a relatively standardized metric that companies across different industries can use for comparison, making it easier to assess their relative value.
Possibility of profit manipulation: Profit is significantly affected by accounting methods and management operations, making it easier to manipulate. Sales revenue is relatively more difficult to manipulate and serves as a more reliable indicator. Unlike profit, sales revenue is not as susceptible to accounting methods and management operations, which gives the price-to-sales ratio higher stability and enables it to more accurately reflect the company’s true value.

Limitations of the P/E Ratio

Simply put, the P/E Ratio depends on EPS, which in turn depends on earnings. For companies with losses or unstable earnings, the P/E Ratio can easily become ineffective. Furthermore, earnings can be falsified through various means, with common methods including:

Choice of Accounting Standards: Companies can choose different accounting standards (such as depreciation methods, revenue recognition methods, etc.), and these choices will directly affect the calculation of profits.
One-time Gains and Losses: Companies can generate one-time gains or losses through asset sales, restructuring, and other methods, thereby affecting profitability in the short term.
Expense Capitalization: Companies can capitalize certain expenses (such as R&D costs) instead of expensing them immediately, thereby increasing current period profits.
Related Party Transactions: Companies can artificially increase revenue or reduce costs by conducting transactions with related parties, thereby improving profitability.

However, the P/S Ratio is actually related to sales data, which is harder to manipulate compared to profitability. Specifically:

Directness: Sales revenue is the most fundamental business activity of a company, typically supported by authentic transaction records and difficult to fabricate out of thin air.
Audit Trail: Auditors will conduct a strict audit of the company’s sales, verifying evidence such as sales contracts, invoices, and bank statements.
Transparency: Sales revenue typically needs to be disclosed in detail in financial statements, including the composition of sales, regional distribution, etc., which increases the difficulty of manipulation.

Valeant Scandal

Valeant is a pharmaceutical company with a long history, dating back to 1959. However, it was investigated by the SEC (U.S. Securities and Exchange Commission) in 1977, indicating that the company has a predisposition toward financial fraud. In its early years, the SEC had limited authority, so no significant penalties were imposed.

For stories about its history, you can read the reference materials. We will briefly focus on its story from 2008 to 2016.

In 2003, the company was renamed from ICN to Valeant Pharmaceuticals International in an attempt to erase its past legal blemishes (now known as Bausch Health Companies Inc). After the name change, Valeant’s stock price remained sluggish until 2008, when the company appointed Michael Pearson, a senior McKinsey executive and pharmaceutical acquisition expert, as its new CEO. Pearson had worked at McKinsey for many years and was a veteran in finance, but he had no relevant management experience before leaving McKinsey.

After becoming CEO of Valeant, Pearson believed that the research and development of patented drugs was a scam, and that acquisitions were the only reliable way to create shareholder value. Additionally, during his time at ICN and his attempts at drug development, unpleasant experiences with confirming true R&D capabilities and various approval processes led both the board and Valeant’s employees to agree with his viewpoint.

What followed was a smooth buying spree. Valeant spent $1 billion on a crazy acquisition of about 30 pharmaceutical and biotechnology companies. After the acquisition, it immediately carried out rectification and stripped off all unnecessary costs, including most of the drug research and development capabilities. It then operated the existing drugs of the acquired companies as cash cows until they expired after the patent protection period and were replaced by low-cost generic drugs.

Clearly, this is all financial manipulation. Under this acquisition and restructuring model, Valeant cut its overall R&D costs to 6% of sales (the industry average was 18%), transforming itself into an acquisition giant. However, the problem is that the pharmaceutical industry itself may not support this model.

The patent protection period for most patented drugs typically lasts 8–10 years, while drugs from newly acquired companies usually have 4–5 years of protection remaining. It is generally difficult to recover the initial investment amount within 4–5 years, so this strategy requires taking on debt to maintain profit growth through a significant increase in debt. Unless Valeant could address the impact of drug expiration on profits after the patent protection period, but this is a structural issue that is difficult to resolve. Given that the CEO had a strong financial background, they chose financial fraud, using accounting methods to increase company profits.

At the end of 2008, when Pearson became CEO, Valeant’s stock price was $9.65. By July 2015, the stock price had surged to $236.10, an increase of nearly 20 times, followed by a steep decline.

The Turning Point

The turning point came in May 2014 when professional short-selling institutions discovered anomalies in its data. After conducting their own research, these firms found that Valeant may have used aggressive accounting practices to manipulate its financial statements, making the company’s financial position appear much healthier than it actually was. The reports from these short-selling institutions attracted significant attention, and between August 2015 and February 2016, Valeant’s stock price fell by 60%. In February 2016, the SEC also launched an investigation, reaching the general conclusion that:

Aggressive Acquisition Strategy: Valeant rapidly increased revenue and profits through numerous acquisitions of pharmaceutical companies. However, the “goodwill” and “intangible assets” from these acquisitions required amortization. Through aggressive accounting practices, such as extending amortization periods and significantly writing down the value of acquired assets, Valeant reduced amortization expenses, thereby artificially inflating profits.
Specialty Pharmacy Relationship (Philidor): Valeant had a close relationship with a specialty pharmacy named Philidor. Through Philidor, Valeant could control the drug distribution channels, artificially inflate sales figures, and return unsold drugs without recording them as returns. This allowed Valeant to artificially inflate its revenue and conceal the true sales situation.
Raising Drug Prices: Valeant significantly increased the prices of the drugs it acquired to boost revenue and profits. Although the revenue figures looked good on paper, this did not bring actual growth to the company.

Valeant made the P/E Ratio meaningless by increasing revenue through acquisitions and reducing costs through accounting treatments. Although we say the P/S Ratio is more difficult to manipulate, in the case of Valeant, the company manipulated sales through its relationship with Philidor, thus achieving fraud as well. Consequently, the P/S Ratio also lost its practical reference value.

For the P/S Ratio to be effective, one underlying assumption is that sales figures reflect the company’s true operational status and that future sales can be converted into profits. However, if sales are significantly manipulated, this assumption no longer holds true. Even if the P/S Ratio appears low, it may simply be because sales have been inflated, while the company lacks genuine profitability.

How to Calculate P/S Ratio

First, the data still comes from the company’s financial statements. Similar to the P/E Ratio, the P/S Ratio also has 2 types:

1. TTM P/S Ratio (Trailing Twelve Months P/S Ratio)

Description: Calculated using actual sales data from the past 12 months (most recent four quarters).
Advantages: Based on actual historical data, relatively reliable.
Disadvantages: May not well reflect the company’s recent development trends, especially for rapidly growing companies.
Formula: P/S Ratio = Market Capitalization / Total Revenue Over The Last 4 Quarters

2. Forward P/S Ratio (Expected P/S Ratio / Estimated P/S Ratio)

Description: Calculated using revenue forecasts from analysts or company management for a future period (typically the next quarter or year).
Advantages: It can reflect the market’s expectations for the company’s future growth.
Disadvantages: Relies on forecasts, which may be inaccurate, leading to distorted price-to-sales ratios.
Formula: P/S Ratio = Market Capitalization / Projected Total Revenue For Next 12 Months

Different P/S Ratios actually use different time windows for calculation, but the basic formula is:

P/S Ratio = Market Capitalization / Total Sales

Market Capitalization: The company’s stock price multiplied by the total number of outstanding shares. Example: If a company’s stock price is 50 yuan and there are 100 million outstanding shares, the market capitalization would be 5 billion.
Total Sales or Revenue: The total sales income of a company during a specific period (usually the past 12 months or the most recent fiscal year). This data can be found in the company’s financial statements (income statement).

Of course, there is another equivalent calculation method: P/S Ratio = Share Price / Sales Per Share, which is calculated based on the share price.

Price per Share: The current market stock price of the company.
Sales per Share: The company’s total sales divided by the total number of shares issued.

Because data is updated at different frequencies — for example, stock prices used in calculations change frequently — the P/S Ratio will fluctuate often. However, the difference between the two calculation methods won’t be significant unless the company’s stock has very high volatility.

Example: NVDA P/S Ratio Calculation

Here we’ll roughly calculate NVDA’s P/S Ratio based on their Q2 2026 quarterly earnings report, which you can view on BestStock: https://beststock.ai/app/analysis/NVDA/fundamentals

As shown in the figure, the condensed consolidated income statement shows that revenue for the three months ended July 27, 2025 was $46.743 billion. Revenue for the six months ended July 27, 2025 was $90.805 billion.

For convenience, we estimate by multiplying quarterly earnings by 4 to calculate revenue for the past 4 quarters (to be more precise, we should actually look up the revenue from each of the past 4 quarters and sum them up).

Projected Annual Revenue = $46.743 Billion × 4 = $186.972 Billion

Then NVDA, as of August 22, 2025, had 24.3 billion common shares outstanding, as shown in the figure below.

At this moment, NVDA’s stock price is $201.03, so:

Market Capitalization = $201.03 × 24.3 Billion Shares = $4.885029 Trillion

Therefore:

P/S Ratio = 4.885029 / 1816.72 = 26.88, which is not significantly different from what BestStock calculated using real data.

End

Reference material: The Valeant scandal: Inside the Enron of pharma

Price-to-Sales Ratio (P/S Ratio) and Financial Fraud

History of the Price-to-Sales Ratio (P/S Ratio)

We’ll start from the beginning to understand why this indicator was proposed and what problems it was designed to solve at the time.

What Issue Does the P/S Ratio Address?

The introduction of the P/S Ratio Mainly Addresses 3 Types of Issues:

Valuation challenges for companies with profitability difficulties or losses: Traditional valuation methods, such as the Price-to-Earnings (P/E) Ratio, cannot be applied when companies have insufficient profits or incur losses. Because the denominator (earnings) is negative or too small, the P/E Ratio becomes meaningless. Many startups, high-growth companies, and enterprises in industry downturns often face profitability challenges, yet these companies may possess significant growth potential. Revenue growth often indicates a company’s future development potential, and the Price-to-Sales (P/S) Ratio can help investors identify companies with high growth potential.
Difficult to compare companies across different industries: Profitability and accounting practices can vary significantly across different industries, making the P/E Ratio less comparable between them. For example, profit margins in the technology sector may be higher than in traditional manufacturing, and directly comparing their price-to-earnings ratios could be misleading. Revenue, however, is a relatively standardized metric that companies across different industries can use for comparison, making it easier to assess their relative value.
Possibility of profit manipulation: Profit is significantly affected by accounting methods and management operations, making it easier to manipulate. Sales revenue is relatively more difficult to manipulate and serves as a more reliable indicator. Unlike profit, sales revenue is not as susceptible to accounting methods and management operations, which gives the price-to-sales ratio higher stability and enables it to more accurately reflect the company’s true value.

Limitations of the P/E Ratio

Choice of Accounting Standards: Companies can choose different accounting standards (such as depreciation methods, revenue recognition methods, etc.), and these choices will directly affect the calculation of profits.
One-time Gains and Losses: Companies can generate one-time gains or losses through asset sales, restructuring, and other methods, thereby affecting profitability in the short term.
Expense Capitalization: Companies can capitalize certain expenses (such as R&D costs) instead of expensing them immediately, thereby increasing current period profits.
Related Party Transactions: Companies can artificially increase revenue or reduce costs by conducting transactions with related parties, thereby improving profitability.

However, the P/S Ratio is actually related to sales data, which is harder to manipulate compared to profitability. Specifically:

Directness: Sales revenue is the most fundamental business activity of a company, typically supported by authentic transaction records and difficult to fabricate out of thin air.
Audit Trail: Auditors will conduct a strict audit of the company’s sales, verifying evidence such as sales contracts, invoices, and bank statements.
Transparency: Sales revenue typically needs to be disclosed in detail in financial statements, including the composition of sales, regional distribution, etc., which increases the difficulty of manipulation.

Valeant Scandal

For stories about its history, you can read the reference materials. We will briefly focus on its story from 2008 to 2016.

The Turning Point

Aggressive Acquisition Strategy: Valeant rapidly increased revenue and profits through numerous acquisitions of pharmaceutical companies. However, the “goodwill” and “intangible assets” from these acquisitions required amortization. Through aggressive accounting practices, such as extending amortization periods and significantly writing down the value of acquired assets, Valeant reduced amortization expenses, thereby artificially inflating profits.
Specialty Pharmacy Relationship (Philidor): Valeant had a close relationship with a specialty pharmacy named Philidor. Through Philidor, Valeant could control the drug distribution channels, artificially inflate sales figures, and return unsold drugs without recording them as returns. This allowed Valeant to artificially inflate its revenue and conceal the true sales situation.
Raising Drug Prices: Valeant significantly increased the prices of the drugs it acquired to boost revenue and profits. Although the revenue figures looked good on paper, this did not bring actual growth to the company.

How to Calculate P/S Ratio

First, the data still comes from the company’s financial statements. Similar to the P/E Ratio, the P/S Ratio also has 2 types:

1. TTM P/S Ratio (Trailing Twelve Months P/S Ratio)

Description: Calculated using actual sales data from the past 12 months (most recent four quarters).
Advantages: Based on actual historical data, relatively reliable.
Disadvantages: May not well reflect the company’s recent development trends, especially for rapidly growing companies.
Formula: P/S Ratio = Market Capitalization / Total Revenue Over The Last 4 Quarters

2. Forward P/S Ratio (Expected P/S Ratio / Estimated P/S Ratio)

Description: Calculated using revenue forecasts from analysts or company management for a future period (typically the next quarter or year).
Advantages: It can reflect the market’s expectations for the company’s future growth.
Disadvantages: Relies on forecasts, which may be inaccurate, leading to distorted price-to-sales ratios.
Formula: P/S Ratio = Market Capitalization / Projected Total Revenue For Next 12 Months

Different P/S Ratios actually use different time windows for calculation, but the basic formula is:

P/S Ratio = Market Capitalization / Total Sales

Market Capitalization: The company’s stock price multiplied by the total number of outstanding shares. Example: If a company’s stock price is 50 yuan and there are 100 million outstanding shares, the market capitalization would be 5 billion.
Total Sales or Revenue: The total sales income of a company during a specific period (usually the past 12 months or the most recent fiscal year). This data can be found in the company’s financial statements (income statement).

Of course, there is another equivalent calculation method: P/S Ratio = Share Price / Sales Per Share, which is calculated based on the share price.

Price per Share: The current market stock price of the company.
Sales per Share: The company’s total sales divided by the total number of shares issued.

Example: NVDA P/S Ratio Calculation

Here we’ll roughly calculate NVDA’s P/S Ratio based on their Q2 2026 quarterly earnings report, which you can view on BestStock: https://beststock.ai/app/analysis/NVDA/fundamentals

Projected Annual Revenue = $46.743 Billion × 4 = $186.972 Billion

Then NVDA, as of August 22, 2025, had 24.3 billion common shares outstanding, as shown in the figure below.

At this moment, NVDA’s stock price is $201.03, so:

Market Capitalization = $201.03 × 24.3 Billion Shares = $4.885029 Trillion

Therefore:

P/S Ratio = 4.885029 / 1816.72 = 26.88, which is not significantly different from what BestStock calculated using real data.

End

Reference material: The Valeant scandal: Inside the Enron of pharma

TOC

Price-to-Sales Ratio (P/S) and Financial Fraud

Price-to-Sales Ratio (P/S Ratio) and Financial Fraud

History of the Price-to-Sales Ratio (P/S Ratio)

What Issue Does the P/S Ratio Address?

Limitations of the P/E Ratio

Valeant Scandal

The Turning Point

How to Calculate P/S Ratio

1. TTM P/S Ratio (Trailing Twelve Months P/S Ratio)

2. Forward P/S Ratio (Expected P/S Ratio / Estimated P/S Ratio)

Example: NVDA P/S Ratio Calculation

End

TOC

Price-to-Sales Ratio (P/S) and Financial Fraud

Price-to-Sales Ratio (P/S Ratio) and Financial Fraud

History of the Price-to-Sales Ratio (P/S Ratio)

What Issue Does the P/S Ratio Address?

Limitations of the P/E Ratio

Valeant Scandal

The Turning Point

How to Calculate P/S Ratio

1. TTM P/S Ratio (Trailing Twelve Months P/S Ratio)

2. Forward P/S Ratio (Expected P/S Ratio / Estimated P/S Ratio)

Example: NVDA P/S Ratio Calculation

End