Enterprise Value-to-Sales (EV/Sales)

Definition

Enterprise Value-to-Sales (EV/Sales) is a financial ratio that measures the value of a company, including its debt and excluding cash, relative to its revenue. The ratio is used to determine the value of a firm in the event of a buyout. A lower EV/Sales ratio could indicate that a company is undervalued, while a higher ratio may suggest overvaluation.

Phonetic

Enterprise Value-to-Sales – pronounced as: /ˈɛntərˌpraɪz ˈvæljuː tuː seɪlz/ (EV/Sales) – /ˌiː viː ˈseɪlz/

Key Takeaways

1. Understanding Enterprise Value-to-Sales (EV/Sales): The EV/Sales ratio is a valuation measure that compares a company’s enterprise value (EV) to its sales. A lower ratio can indicate a company is undervalued, while a higher ratio can imply it is overvalued or expected to grow significantly.
2. Application of EV/Sales: The EV/Sales is broadly used in assessing the value of companies in high growth industries (e.g. technology or emerging markets) where the earnings may not be a precise reflection of the company’s progress. It offers a more comprehensive view as it takes into account factors like debt and cash on hand which are not considered in Price to Sales Ratio.
3. Comparison with Other Ratios: Unlike the P/E ratio, the EV/Sales is less affected by the different accounting methods companies use for earnings. But like any financial ratios, it should not be used in isolation. Investors need to consider other factors such as industry comparisons, historical averages, and forward estimates to make sound investment decisions.

Importance

The Enterprise Value-to-Sales (EV/Sales) ratio is an important valuation tool in finance and business because it provides a comprehensive, holistic view of a company’s value relative to its sales revenue. The metric considers both the company’s equity and debt, offering a clearer picture of its total value than the standard price-to-earnings (P/E) ratio. This ratio is especially useful in understanding and comparing the value of companies with significant debt or that are not currently generating profits. It’s particularly relevant for analyses of companies within high growth, high investment industries, like technology or pharmaceutical firms. Consequently, the EV/Sales ratio is essential in business analyses and investment decisions, providing more context and understanding of a company’s financial standing.

Explanation

The Enterprise Value-to-Sales (EV/Sales) ratio provides investors, analysts, and other stakeholders with a comprehensive measure of a company’s total value relative to its sales. It is instrumental in assessing the worth and performance of a firm, specifically when comparing it with rivals within the same industry. This ratio uses Enterprise Value which includes not only the market capitalization of a company but also short-term and long-term debt and cash, thereby giving a more inclusive picture of a company’s financial health. The EV/Sales ratio is particularly used when valuing businesses with little or no profits, like those in the early stages of development or technology firms, where typical valuation metrics like Price-to-Earnings (P/E) ratio may be less helpful. A lower EV/Sales ratio might suggest that a company is undervalued, providing an opportunity for investors. However, this ratio should be used cautiously as an isolated measure is not sufficient to make investment decisions. It should be used in conjunction with other financial ratios and metrics to gain a more comprehensive understanding of a company’s valuation and future prospects.

Examples

Enterprise Value-to-Sales (EV/Sales) is a financial metric that measures the total value of a company, including its market capitalization, debt and cash, in relation to its sales revenue. Below are three real-world examples: 1. Alphabet Inc. (Google’s parent company): If Alphabet, in 2020, had an enterprise value of $1 trillion and sales revenue of $182 billion, its EV/Sales ratio would be approximately 5.5. This means the market values Alphabet at 5.5 times its sales revenue. 2. Amazon Inc.: Amazon, in 2019, reported an enterprise value of $888 billion, with sales revenue of $280 billion. So, its EV/Sales ratio was around 3.2 that year, implying that for every dollar of sales, the market valued the company at about $3.2. 3. Tesla Inc.: In the same year, Tesla had an enterprise value of about $40 billion and sales revenue of $21 billion, giving it an EV/Sales ratio of approximately 1.9. This ratio allows investors to compare the company’s value to companies within the same industry to determine whether it is overvalued or undervalued.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Enterprise Value (EV)
• Revenue or Sales
• Financial Ratio
• Business Valuation
• Equity Value

Sources for More Information

• Investopedia
• Corporate Finance Institute
• WallStreetMojo
• Wikipedia