Enterprise Value to Sales Ratio

What is Enterprise Value to Sales Ratio?

Enterprise Value to Sales Ratio (EV/Sales) is a financial metric that investors use to measure a company’s total value in relation to its sales. The first part of the ratio is the Enterprise Value. A company’s enterprise value is the sum of its current market cap, debt, minority interest, preferred shares after deducting its cash balances.

Enterprise value to sales ratio is a crucial metric that investors use to calculate a stock's market value. Using this ratio, investors can determine whether a company's stock in the market is undervalued or overvalued. Usually, a higher EV/Sales ratio represents an expensive or valuable stock. Another name for the ratio is the Enterprise Value to Revenue ratio or multiple.

How to Calculate the Enterprise Value to Sales Ratio?

Calculating the EV/Sales ratio is straightforward. As the name suggests, it is the ratio of a company’s enterprise value and its sales. Therefore, the formula will be as follows.

Enterprise Value to Sales Ratio = Enterprise Value / Net Sales

A company’s net sales are available in its Income Statement. However, investors need to calculate the Enterprise Value manually. They may need to obtain the information for this calculation from external and internal sources. The formula to calculate Enterprise Value is as below.

Enterprise Value = Market Capitalization + Debt + Preferred Shares + Minority Interest - Cash and Cash Equivalent Balances

Most of the information available for the above formula is available in a company's Balance Sheet. However, the market capitalization may need some external research.

Example

A company, Green Co., has a total market capitalization of $100 million. The company reports total debt of $20 million and preferred shares of $15 million in its balance sheet. Green Co. also has cash and cash equivalent balances of $25 million. The company made total sales of $50 million. Before determining Green Co.'s EV/Sales ratio, it is crucial to calculate its Enterprise Value.

The calculation for Green Co.’s Enterprise Value will be as follows.

Enterprise Value = Market Capitalization + Debt + Preferred Shares + Minority Interest - Cash and Cash Equivalent Balances

Enterprise Value = $100 million + $20 million + $15 million - $25 million

Enterprise Value = $110 million

Therefore, Green Co.’s Enterprise Value to Sales Ratio will be as follows.

Enterprise Value to Sales Ratio = Enterprise Value / Net Sales

Enterprise Value to Sales Ratio = $110 million / $50 million

Enterprise Value to Sales Ratio = 2.2

How does the Enterprise Value to Sales Ratio work?

The EV/Sales ratio allows investors to evaluate a company's stocks. It is similar to the price-to-sales ratio (P/S). However, it uses a company's enterprise value instead. The EV/Sales ratio may range between 1 and 3. Investors usually prefer to invest in companies with a low EV/Sales ratio as it may indicate undervalued stocks. However, that may not always be true.

Sometimes, a high EV/Sales ratio can also mean the companies have a high potential to grow their sales. Similarly, a low EV/Sales ratio may indicate a company has experienced a sudden or one-off increase in its revenues. This ratio provides better results if used comparatively with a company's past performances or the industry as a whole.

Conclusion

The Enterprise Value to Sales Ratio considers the ratio between a company’s Enterprise Value and its Revenues. This financial metric is crucial for investors that want to identify undervalued or overvalued stock in a company. Usually, investors prefer investing in low EV/Sales ratio companies. However, there may be some exceptions to that rule.

Originally Published Here: Enterprise Value to Sales Ratio