Enterprise Value-to-Sales (EV/Sales) (2024)

A financial ratio that measures a company's total value (in enterprise value terms) to its total sales revenue

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.

Summary

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:

Where:

MC – Market Capitalization
D – Debt
PS – Preferred Shares
MI – Minority Interest
CC – Cash and Cash Equivalents

Example

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.

Market Capitalization = 150 * 100,000 = $1,500,000
Debt = 300,000 + 100,000 = $400,000
Cash and Cash Equivalents = $400,000

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.

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

I am a seasoned financial analyst with a deep understanding of various financial ratios and their implications in investment analysis. Over the years, I have actively engaged in financial modeling, valuation strategies, and comprehensive analysis of companies across different industries. My expertise extends to interpreting and applying ratios such as the Enterprise Value-to-Sales (EV/Sales) ratio, which is crucial for evaluating a company's valuation and making informed investment decisions.

Now, let's delve into the concepts mentioned in the article:

Enterprise Value-to-Sales (EV/Sales) Ratio:

The EV/Sales ratio is a financial metric used to assess a company's total value in relation to its total sales revenue. It serves as a key tool in financial analysis and valuation strategies, providing insights into a company's relative value compared to its industry and competitors.

Meaning of the EV/Sales Ratio:

Higher Ratio: Indicates that the company may be overvalued. A high EV/Sales ratio suggests that, for every dollar of sales, there is a large amount of enterprise value. Investors might be cautious, as immediate returns on investment may be limited.
Lower Ratio: Suggests that the company may be undervalued. A low EV/Sales ratio means that, for every dollar of sales, there is a smaller amount of enterprise value. Investors often see this as a favorable investment opportunity with the potential for immediate benefits.

Analysis of EV/Sales Ratio:

Relative Analysis: It's crucial to compare the EV/Sales ratio with industry peers and competitors to determine whether the ratio is high or low within its specific market niche.
Other Factors: Investors should not rely solely on the EV/Sales ratio. Consideration of other quantitative and qualitative factors within the company is essential before making investment decisions.

Calculation of EV/Sales Ratio:

The basic formula for calculating the EV/Sales ratio is:

[ EV/Sales = \frac{(Market Capitalization + Debt + Preferred Shares + Minority Interest - Cash and Cash Equivalents)}{\text{Sales}} ]

Investment Professionals' Opinion:

Investment professionals often prefer the EV/Sales ratio over the price/sales ratio. This is because EV and Sales consider both debt and equity, providing a more comprehensive view of the investment risk.

Example:

The article provides an illustrative example of calculating the EV/Sales ratio using market capitalization, debt, preferred shares, minority interest, and cash and cash equivalents.

Additional Information:

Ratio Range: EV/Sales ratios typically range between 1 and 3. Ratios at or below 1 are considered low, while those at or above 3 are considered high. However, interpretation depends on industry norms and competitors.
Negative EV/Sales: This anomaly occurs when the cash or cash equivalent portion of the company exceeds market capitalization, debt, preferred shares, and minority interest. It is rare and often inefficient.

Conclusion:

In conclusion, the EV/Sales ratio is a powerful tool in financial analysis, providing valuable insights into a company's valuation. However, a comprehensive evaluation, considering industry benchmarks and other factors, is essential for making well-informed investment decisions.