Enterprise Value-to-Sales (EV/Sales)

What Is Enterprise Value-to-Sales (EV/Sales)?

Enterprise value-to-sales (EV/sales) is a financial valuation measure that compares the enterprise value (EV) of a company to its annual sales. The EV/sales multiple gives investors a quantifiable measurement of how to value a company based on its sales while assessing both the company's equity and debt.

The Formula for Enterprise Value-to-Sales

$\begin &\text{EV/Sales} = \frac{ \text + \text - \text }{ \text } \ &\textbf\ &\text = \text \ &\text = \text \ &\text = \text \ \end$

The most effective method to Calculate Enterprise Value-to-Sales

Enterprise value-to-sales is calculated by:

Adding total debt to a company's market cap
Subtracting out endlessly cash equivalents
And afterward isolating the result by the company's annual sales

A slightly more complicated version of enterprise value with a couple of additional variables is sometimes used. The more complex formula for EV is:
$\begin &\text = \text + \text + \text + \text - \text \ &\textbf\ &\text = \text \ &\text = \text \ \end$

What Does Enterprise Value-to-Sales Tell You?

Enterprise value-to-sales is an expansion of the price-to-sales (P/S) valuation, the last option of which uses market capitalization instead of enterprise value. EV/Sales is perceived to be more accurate than P/S, in part, because the market capitalization alone does not consider a company's debt while esteeming the company, while enterprise value does.

EV-to-sales multiples are usually found to be somewhere in the range of 1x and 3x. Generally, a lower EV/sales multiple will show that a company might be more alluring or undervalued in the market. The EV/sales measure can also be negative when the cash balance of the company is greater than the market capitalization and debt structure, signaling that the company can essentially be bought with its own cash.

The EV-to-sales measure can, however, be slightly deceptive in that a higher multiple is not always a signal of over-valuation. A high EV-to-sales can be a positive sign that investors believe that future sales will extraordinarily increase. A lower EV-to-sales can likewise signal that future sales prospects are not extremely appealing.

To make the most out of this measurement, compare the EV-to-sales to that of different companies in the same industry, and look deeper into the company you are examining.

Example of How to Use Enterprise Value-to-Sales

Assume that a company reports sales for the extended period of $70 million. The company has $10 million of short-term liabilities on the books and $25 million of long-term liabilities. It has $90 million worth of assets, with 20% of that in cash. Lastly, the company has 5 million shares of common stock outstanding and the current price of the stock is $25 per share. Using this scenario, the company's enterprise value is:
$\begin \text &= \text{Market Cap (5 Million Shares} \times \text{$25 Stock Price)} \ &\quad + \text{Total Debt ($10 Million} + \text{$25 Million)} \ &\quad - \text{Cash ($90 Million} \times 20%) \ &= $125 \text + $35 \text - $18 \text \ &= $142 \text \end$
Then, to track down the EV-to-sales, simply partition the calculated enterprise value by sales. In this example, the EV-to-sales is:
$\begin &\text{EV/Sales} = \frac{ $142 \text }{ $70 \text } = 2.03 \ \end$
Taking the EV/sales ratio a step further, consider Coca-Cola. The company has a market cap of $237 billion as of Dec. 31, 2019.

Its total debt as of Dec. 31, 2019, was $42.8 billion.
Endlessly cash equivalents are $6.5 billion as of December 31, 2019.
Sales over the trailing 12 months for Coca-Cola have been $37.2 billion.
EV for Coca-Cola is $273.3 billion, or $237 billion + $42.8 billion - $6.5 billion.

EV/sales = 7.3x, or $273.3 billion/$37.2 billion.

Enterprise Value-to-Sales vs. Price-to-Sales

The EV-to-sales ratio takes into account the debt and cash a company has. The price-to-sales ratio, in the mean time, does not. The price-to-sales ratio is faster to work out, using just a company's market cap as the numerator. However, debtholders truly do have a claim on sales and should hypothetically be remembered for the valuation.

Limitations of Using Enterprise Value-to-Sales

The EV/sales ratio requires computing the enterprise value, which involves somewhat more diving into financial statements. EV is generally used for esteeming acquisitions, where the acquirer will assume the debt of the company, yet in addition get the cash. One more limitation to know about is that sales don't consider a company's expenses or taxes.

Highlights

This measurement is considered more accurate than the connected price-to-sales because EV/sales takes into account a company's debt load.
Enterprise value-to-sales (EV/sales) is a financial ratio that measures the amount it would cost to purchase a company's value in terms of its sales.
A lower EV/sales multiple indicates that a company is a more appealing investment as it very well might be moderately undervalued.