EV to Sales

Updated on May 6, 2024
Article bySayantan Mukhopadhyay
Reviewed byDheeraj Vaidya, CFA, FRM

What is EV to Sales Ratio?

EV to Sales Ratio is the valuation metric used to understand the company’s total valuation compared to its sale. It is calculated by dividing the enterprise value (Current Market Cap + Debt + Minority Interest + preferred shares – cash) by its annual sales.

Have a look at the above Box IPO Financial model with forecasts. We note that BOX is making losses at the Operating and net income levels. How do you value such companies that grow fast but are free cash flow negative?

In such cases, we cannot apply valuation multiples like PE ratio (due to negative earnings), EV to EBITDA (if EBITDA is negative), or DCF approach (when FCFF is negative). The valuation tool that comes to our rescue is EV to Sales.

Box IPO Ev to Sales

In this article, we will dig deeper –

Key Takeaways

  • The EV-to-Sales ratio offers a method to assess a company’s overall valuation relative to its revenue. It’s computed by dividing the comprehensive enterprise value (encompassing market capitalization, debt, minority interest, and preferred shares minus cash) by the company’s yearly sales.
  • In contrast to the Price-to-Sales (P/S) ratio, the EV/Sales ratio emerges as a more robust yardstick for company valuation. Unlike P/S, which disregards debt, the EV/Sales ratio provides a comprehensive view, making it necessary for an accurate valuation.
  • While the EV/Sales ratio provides valuable insights, prudent investment decisions necessitate a broader approach. Relying on a spectrum of ratios and gathering substantiated information before investing is crucial. 

What do we mean by Enterprise Value to Revenue Ratio?

EV / Sales is an interesting ratio. It considers the enterprise value, and then the enterprise value is compared with the company’s sales. We estimate how much it costs to investors relative to per-unit sales with this ratio. Now, why should we calculate this ratio?

From the investor’s point of view, two interpretations are most important –

  • If this ratio is higher, then it is considered that the company is costlier, and it’s not a good bet for investors to invest in because they won’t be getting any immediate benefit from this investment.
  • If this ratio is lower, it is considered a great investment opportunity for investors; when EV / Sales is lower, it is perceived as undervalued. If the investors invest, they will benefit from it.

So if you are an investor and thinking of investing in a company, but don’t know whether it’s a good bet, calculate Enterprise Value to Sales ratio, and you will know! If it’s higher, stay away from investment; and if it’s lower, go ahead and invest in the company (subject to the other ratios because, as an investor, you shouldn’t take any decision based on only one ratio).

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Enterprise Value to Sales Formula

Enterprise Value to Sales Formula

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Source: EV to Sales (wallstreetmojo.com)

Let’s start with Enterprise Value (EV). To find out the enterprise value, we need to know three specific things – market capitalization, the debt that is yet to be paid, and the cash and bank balance.

Here’s the formula of Enterprise Value (EV) –

EV = Market Capitalization + Outstanding Debt – Cash & Bank balances

Now, we need to find out how they should be considered.

Market Capitalization is the value we get when we multiply the company’s outstanding shares by the market price of each share. How should we calculate it? Here’s how –

Let’s say Company A has outstanding shares of 10,000, and the market price of each of the shares at this moment is US $10 per share. So, the market capitalization would be = (outstanding shares of the Company A * market price of each share at this moment) = (10,000 * US $10) = US $100,000.

Outstanding debt is the long-term liabilities the firm needs to pay back in the long run.

Cash & bank balances are the liquid assets of the company, which need to be deducted from the total market capitalization and outstanding debt. (Also, look at a detailed article on Cash & Cash Equivalents)

We have understood all the Enterprise Value (EV) components, which we can now calculate. Let’s now talk about Sales.

What would we consider “sales” in this ratio?

When we take sales, it is net sales, not gross sales. A gross sale is a figure inclusive of the sales discount and sales returns. We would take the net sales, which means we must exclude sales discounts and sales returns (if any) from the gross sales to get the right figure.

EV to Revenue Examples

Let’s look at a few examples to understand how to calculate the enterprise value to sales. We will look at a simple example first, then illustrate the ratio with two complex examples.

Example # 1

We have the following information –

DetailsIn US $
Market Price of Share15 / share
Outstanding Shares100,000 shares
Long term liabilities2000,000
Cash & Bank balances40,000
Sales1,000,000


Calculate the Enterprise Value and the ratio of EV / Sales.

It is a simple example, and we will follow along, as we have explained before.

First, we will calculate the market capitalization by multiplying the outstanding shares by the market price per share.

DetailsIn US $
Market Price of Share (A)15 / share
Outstanding Shares (B)100,000 shares
Market Capitalization (A * B)1,500,000

Now, as we have market capitalization, we can calculate the enterprise value (EV).

DetailsIn US $
Market Capitalization1,500,000
(+) Long term liabilities2,000,000
(-) Cash & Bank balances(40,000)
Enterprise Value (EV)3,460,000

We know the enterprise value and sales are already mentioned. So now, we can ascertain the multiple

DetailsIn US $
Enterprise Value (EV)3,460,000
Sales1,000,000
EV / Sales3.46

Depending on the industry, investors need to understand whether 3.46 is a higher or lower ratio, and then the investor can decide whether to invest in a company or not.

Example # 2

Let’s look at the following information –

DetailsIn US $
Market Price of Share12 / share
Book value per share10 / share
Book Value of Shares2,500,000
Long term debt3,000,000
Cash & Bank balances500,000
Gross Sales1,500,000
Sales Return400,000


Compute enterprise value (EV) and the ratio EV / Sales.

In this example, the computation is a bit complex. First, we need to find out the number of shares, and then we will be able to compute the market capitalization.

So, let’s find out the outstanding shares first.

DetailsIn US $
Book Value of Shares (A)2,500,000
Book value per share (B)10 / share
Outstanding Shares (A / B)250,000 shares

We know the market price per share, and now we have the exact number of outstanding shares. Then we can compute the market capitalization right away –

DetailsIn US $
Outstanding Shares (C)250,000 shares
Market Price of Share (D)12 / share
Market Capitalization (C * D)3,000,000

We now have market capitalization. So it would be easier to calculate enterprise value. Let’s calculate the enterprise value now –

DetailsIn US $
Market Capitalization3,000,000
(+) Long term liabilities3,000,000
(-) Cash & Bank balances(500,000)
Enterprise Value (EV)5,500,000

We will now calculate net sales. As we cannot include gross sales in the ratio, we need to deduct sales return from the gross sales and first find out the net sales.

DetailsIn US $
Gross Sales1,500,000
(-) Sales Return(400,000)
Net Sales1,100,000

We now have enterprise value and net sales as well. So we can ascertain this ratio.

DetailsIn US $
Enterprise Value (EV)5,500,000
Sales1,100,000
EV / Sales5.00x

Enterprise value to Sales is 5x, which is higher or lower depending on the firm’s industry. So if the EV / Sales of the industry are usually higher, then the investors can invest in the company. And if it is not the case, the investors need to think twice before investing in the company. But as an investor, it’s of primary importance that you check with all other ratios to come up with a concrete conclusion.

When to use EV/Sales?

  • EV to Revenue is very difficult to game from an accounting point of view. Though it is a crude measure, it does provide us with great insights into how much we are paying for the company per-unit sales.
  • It can be very helpful when there are significant differences in the accounting policies of companies. On the other hand, the PE ratio can vary dramatically with changes in accounting policies.
  • It can be used for companies with negative free cash flows or unprofitable companies. Most internet e-commerce startups (running unprofitably) like Flipkart, Uber, Godaddy, etc. can be valued using EV/Sales.
Godaddy Operating Loss EV to Sales
  • EV/sales can be useful for identifying restructuring potential. 
    In his discussion on restructuring, Andrew Griffin noted that Alcatel-Lucent was reporting losses each year and was valued at 0.1x Ev/Sales. The rule-of-thumb was that a mature company should trade at an EV/sales of its EBIT margin percentage, divided by 10. So if the EBIT margin was expected to be 10%, it should trade at 1x multiple; if it was expected to be 5%, then 0.5xEV/Sales. Andrew expected that the company would reach at least 3% EBIT margins, and hence, it looked undervalued

Which is Better – EV to Sales vs. Price to Sales?

First thing first, the Price to Sales ratio is technically incorrect. Price per share is the price at which one can buy a share, i.e., it belongs to the shareholder or the equity holder. However, it is a pre-debt item when we consider the denominator – Sales. It means that we haven’t paid off interest, and hence, it belongs to both the debt holder and the equity holder. The numerator belongs to the equity holder, and the denominator belongs to both the debt and equity holders. It makes apples to oranges comparison and is, therefore, incorrect.

EV / Sales is a better ratio than the P/S Ratio. However, you will still find many analysts using this ratio. In the Price to Sales ratio, an analyst may be using market capitalization to understand how much it costs to purchase the company. However, in P/S, debt is not considered. If a company has huge amounts of debt in its capital structure, the valuation inferences drawn from the Price to Sales ratio will be incorrect.

Let us take the example of Godaddy.

If you observe the EV to Sales and Price To Sales trend of Godaddy, you will note a marked difference in both ratios. Why?

Godaddy-EV-to-Sales

source: ycharts

To answer this question, we need to understand the following concept.

Enterprise value = Market Cap + Debt – Cash.

Now when do you think enterprise value will be very different from Market Capitalization. It can happen when (Debt – Cash) is a significant number.

Godaddy Large Debt to Equity

source: Godaddy SEC Filings

Godaddy’s Balance Sheet reveals the presence of large amounts of debt ($1,039.8 million). Its Debt to Equity Ratio is greater than 2.0x. However, Godaddy has a cash & cash equivalent of $352 million. The contribution of (Debt – Cash) is pretty significant in the case of Godaddy, and hence, both the ratios differ.

Let us now contrast this with Amazon. Amazon Price to Sales ratio and EV Sales ratio almost mimic each other.

Amazon-EV-to-Sales

source: ycharts

Amazon’s Debt to Equity ratio is low (less than 0.75x), and they have a huge pile-up of cash. Due to this, (Debt – Cash) does not contribute to the Enterprise Value of Amazon meaningfully. Therefore, we note that Price to Sales and EV to Sales of Amazon are similar.

amazon Debt to Equity

source: Amazon SEC Filings

Using EV to Sales for Box IPO Valuation

#1 – Comparable Comps Method using EV / Sales

Please note that I did this Box IPO Valuation a long time back, and I have not updated the numbers since then. However, from understanding the EV/Sales point of view, this example is still valid.

For a quick comparable comp analysis SaaS companies, I took the SaaS companies data from the BVP Cloud Index.

Box IPO - SAAS Comparable Valuation Table

We note that Box is not profitable and negative at the EBITDA level. The only option to value such a company with negative free cash flows is to use EV/Sales.

We make the following observations from the above table.

  • Cloud companies are trading at an average of 9.5x EV/Sales Multiple.
  • We note companies like Xero are an outlier that trades at 44x EV/Sales multiple (expected 2014 growth rate of 94%).
  • Cloud companies trade at an EV/EBITDA multiple of 32x.

Box Valuation

Box IPO Relative Valuation
  • Box Inc valuation range from $11.02 (pessimistic case) to $24.74 (optimistic case)
  • The most expected valuation for Box Inc using Relative Valuation is $16.77 (expected)

#2 – Comparable Acquisition Analysis using EV/Sales

Here we use the comparable acquisition method to find the value of Box IPO. We note all the transactions in a similar domain and their Enterprise Value to Sales ratio.

Below are some of the large M&A transactions in the recent past.

SaaS M&A Transaction Comps

Based on the above comparable acquisition analysis, we can arrive at the following conclusions for Box Valuation –

  • The mean Multiple of 7.4x implies a valuation of closer to $1.8 billion (implying a share price of $18.4/share)
  • The highest Multiple of 9.7x implies a valuation of $2.4 billion (implying a share price of $24.7/share)
  • The lowest Multiple of 4.1x implies a valuation of $1.1 billion (implying a share price of $9.3/share)

In the above, the Sales forecast used for Box is $248,38 million.

Limitations of Enterprise Value to Sales

EV / Sales is a good metric to determine whether to invest in a company or not. However, it’s based on many variables that may change in days. And it’s not recommended that the investors depend on a single ratio to decide on an investment. Investors should look at different ratios to develop factual information before investing their money into any investment.

In the final analysis

If you know how to compute EV, you should never bank upon only market capitalization, as the debt should also be considered in the equation.

Enterprise Value to Sales Ratio Video

 

Frequently Asked Questions (FAQs)

1. What is the importance of EV-to-Sales ratio?

The EV-to-Sales ratio is significant as it helps investors assess a company’s valuation in relation to its revenue, providing insights into its market value regardless of its debt structure. This ratio aids in evaluating a company’s sales efficiency and growth potential, giving a clearer picture of its valuation.

2. What are the applications of EV-to-Sales ratio?

The EV-to-Sales ratio finds applications in comparing companies’ valuations within the same industry, identifying potential investment targets, and evaluating how market sentiment aligns with financial performance. It assists in understanding if a company’s valuation is justified based on its revenue generation.

3. Which is better, EV-to-EBITDA or EV-to-Sales?

While both ratios have their merits, EV-to-EBITDA is generally preferred over EV-to-Sales. EV-to-EBITDA considers operational earnings and cash flow, offering a more comprehensive view of a company’s financial health. EV-to-Sales focuses solely on revenue, potentially overlooking important profitability and efficiency aspects.

Reader Interactions

Comments

  1. C Chan says

    I think you are missing a zero for you $10mm long-term liabilities and $20mm for your sales in Example 1. Similarly, Example 2 is missing a zero place for values in the millions.

    • Dheeraj Vaidya says

      thanks Chan for pointing this out. There was a mistake in the “,” that i used in numbers.

  2. Rukky says

    great write up sir!

    By the way I downloaded your material from the free download section… but I have no idea where to start from.

      • Rukky says

        thank you so much for the speedy response,
        I have gone through the ratios actually, I guess I was just overwhelmed with the numbers and how you arrived a each figure in the forecast. I shall take my time to digest the material.
        I shall be in touch again soon.

        Many thanks

  3. Jubair-Al-Mahmud says

    Great write up, Sir!

  4. Karan says

    Mean EV/Sales of 7.4x implies a valuation of closer to $900 million – can you please explain how you got 900?

    • Dheeraj Vaidya says

      Hi Karan, thanks for your question and highlighting a mistake in the calculation. The actual sales forecast of Box was $248 million and multiplying it by 7.4 will give an enterprise value of $1.8 billion.

      thanks,
      Dheeraj
      p.s. I corrected the mistake in the blog post.

  5. Manu says

    Very Helpful. You are doing a great work.
    Thanks a ton!!

  6. Ashrit Kasshyap says

    I don’t agree with your statement that you can’t value a company who’s fcfe/fcff is negative using DCF. You could project cash flows (even when negative) and still compute the value as long as you have a positive terminal value(with stable mature growth in perpetuity). In fact all young startups more often than not will have negative cash flows upfront.

    • Dheeraj Vaidya says

      Hi Ashrit,
      You are right. You can still value a company with negative FCFE/FCFF (for next 5-7). This can happen when terminal value is positive in the future estimates. Generally, in Equity Research, we tend to forecast for 5-7 years at max and hence, we give up on finding the terminal value in the distant future. Also, the confidence level shown to a terminal value number (arrived after 20 years of projection) will always remain doubtful for investors.
      Just think of Flipkart etc. Do you think their FCFF will be positive in the next 15-20 years? If not, DCF valuation model will throw a value that will be too theoretical. In such cases, we look at alternate approaches of valuation like Relative Valuation like EV/EBITDA or EV/Sales or some other measure.