Enterprise value-to-sales (EV/Sales) is a financial ratio that measures a company’s total value (in enterprise value terms) to its total sales revenue.
It is further simplified as the EV per a dollar of sales. It means that the higher the ratio, the more “expensive” or valuable the company is and vice versa. It is used for financial analysis and valuation strategies when researching a potential investment.
Enterprise value-to-sales is a financial ratio used to value a company and compare it to its industry and competitors.
When the EV/Sales ratio is higher, the company can be considered overvalued.
When the EV/Sales ratio is lower, the company is considered undervalued.
What Does the Enterprise Value-to-Sales Ratio Mean?
Investors are able to get a better idea of the cost relative to per-unit sales, which is essential when deciding whether to invest in a company. In calculating the said value, investors can better understand whether the company is overvalued or undervalued.
Analysis of Enterprise Value-to-Sales Ratio
When the EV/Sales ratio is higher, the company can be considered more expensive. For every dollar of revenue, there is a large amount of enterprise value. A high ratio is generally not appealing to investors, as they will not benefit from the investment immediately.
A high EV/Sales ratio often means the company is overvalued. However, some investors won’t mind the high ratio if they believe that future sales will increase significantly and provide them with greater returns.
When the EV/Sales ratio is lower, the company is considered undervalued. For every dollar of revenue, there is a smaller amount of enterprise value. Investors generally see it as a good investment opportunity; it usually means that the company is undervalued and can provide immediate benefit to investors.
With high and low EV/Sales in mind, it is crucial to analyze the ratio relative to its competitors and its industry. A low EV/Sales ratio relative to the general market may actually be quite high in its niche industry and not be an attractive investment.
Additionally, there are many other quantitative and qualitative factors within the company to review before basing a purchase decision on this one ratio.
The EV/Sales ratio can be negative if the cash or cash equivalent portion of the company is larger than market capitalization, debt, preferred shares, and minority interest. It means that the company holds enough cash to pay off all of its debt and essentially buy itself. It is an anomaly that does not occur very often, and when it does, it usually doesn’t last long, as it is relatively inefficient.
Investment Professionals’ Opinion
Investment professionals often believe that enterprise value-to-sales is a stronger ratio and provides more valuable information than the price/sales ratio since EV and Sales both consider debt and equity.
Price is pre-financing income and is, therefore, a logical discrepancy. Debt and equity are taken into account with the enterprise value-to-sales ratio. Therefore, the risk of the investment is considered. The price-sales ratio does not include the risk and thus provides less information to the analyst.
Calculation of Enterprise Value-to-Sales Ratio
The most basic way to calculate enterprise value-to-sales is:
MC – Market Capitalization
D – Debt
PS – Preferred Shares
MI – Minority Interest
CC – Cash and Cash Equivalents
A company reports annual sales of $400,000. The company’s current stock price is $150, and there are 100,000 outstanding shares. Cash and cash equivalents amount to $400,000. The company owes $300,000 on a mortgage and another $100,000 in short-term liabilities.
Generally, EV/Sales ratios range between 1 and 3. Anything at or below 1 will be considered a low ratio. Anything at or above a 3 would be regarded as quite high. However, it depends on the industry and the company’s competitors, as previously stated.
An enterprise value-to-sales ratio of 3.75 will be high and may turn potential investors away, as it will be a riskier purchase and require much more time to start making profits.