Best of the Week
Most Popular
1.Canada Real Estate Bubble - Harry_Dent
2.UK House Prices ‘On Brink’ Of Massive 40% Collapse - GoldCore
3.Best Cash ISA for Soaring Inflation, Kent Reliance Illustrates the Great ISA Rip Off - Nadeem_Walayat
4.Understanding true money, Pound Sterling must make another historic low, Euro and Gold outlook! - Marc_Horn
5.5 Maps That Explain The Modern Middle East - GEORGE FRIEDMAN
6.Gold Back With A Vengeance As Bitcoin Bubble Bursts - OilPrice_Com
7.Gold Summer Doldrums - Zeal_LLC
8.Crude Oil Trade & Nasdaq QQQ Update - Plunger
9.Gold And Silver – Why No Rally? Lies, Lies, And More Lies - Michael_Noonan
10.UK Election 2017 Disaster, Fake BrExit Chaos, Forecasting Lessons for Next Time - Nadeem_Walayat
Last 7 days
UK House Prices Momentum Crash Warns of 2017 Bear Market - Video - 22nd Jul 17
Crude Oil, Gold, ETFs & more: Pro-grade Market Forecasts - 22nd Jul 17
Warning: The Fed Is Preparing to Crash the Financial System Again - 21st Jul 17
Gold / Silver Shorts Extreme - 21st Jul 17
GBP/USD Bearish Factors - 21st Jul 17
Gold Hedges Against Currency Devaluation and Cost Of Fuel, Food, Beer and Housing - 21st Jul 17
Is It Worth Investing in Palladium? - 21st Jul 17
UK House Prices Momentum Crash Threatens Mini Bear Market 2017 - 21st Jul 17
The Fed May Show Trump No Love - 20th Jul 17
The 3 Best Asset Classes To Brace Your Portfolio For The Next Financial Crisis - 20th Jul 17
Gold Stocks and Bonds - Preparing for THE Bottom - 20th Jul 17
Millennials Can Punt On Bitcoin, Own Safe Haven Gold For Long Term - 20th Jul 17
Trump Has Found A Loophole To Rewrite Trade Agreements Without Anyone’s Permission - 20th Jul 17
Basic Materials and Commodities Analysis and Trend Forecasts - 20th Jul 17
Bitcoin PullBack Is Over (For Now): Cryptocurrencies Gain Nearly A 50% In Last 48 Hours - 19th Jul 17
AAPL's 6% June slide - When Prices Are Falling, TWO Numbers Matter Most - 19th Jul 17
Discover Why A Major American Revolution Is Brewing - 19th Jul 17
iGaming – Stock Prices - 19th Jul 17
The Socionomic Theory of Finance By Robert Prechter - Book Review - 18th Jul 17
Ethereum Versus Bitcoin – Which Cryptocurrency Will Win The War? - 18th Jul 17
Accepting a Society of Government Tyranny - 18th Jul 17
Gold Cheaper Than Buying Greek Villas in 2012 - 18th Jul 17
Why & How to Hedge the Growing Risks of Holding Stocks - 18th Jul 17
Relocation: Everything You Need to do for a Smooth Transition Abroad - 17th Jul 17
A Former Lehman Brothers Trader: It’s Time To Buy Brick And Mortar Retailers - 17th Jul 17
Bank Of England Warns “Bigger Systemic Risk” Now Than 2008 - 17th Jul 17
Bitcoin Price “Deja Vu” Corrective Sequence - 17th Jul 17
Charting New Low in Speculation in Gold and Silver Markets - 17th Jul 17
Bitcoin Crash - Is This The End of Cryptocurrencies? - 17th Jul 17
The Fed's Inflation Nightmare Scenario - 17th Jul 17
Billionaire Investors Backing A Marijuana Boom In 2017 - 17th Jul 17
Perfect Storm - This Fourth Turning has Over a Decade of Continuous Storms to Come - 17th Jul 17
Gold and Silver Biggest Opportunity Since Late 2015, Last Chance at These Prices - 17th Jul 17
Stock Market More to Go - 17th Jul 17
Emerging Markets & Basic Materials Stocks Breaking Out Together - 16th Jul 17
Stock Market SPX Uptrending Again After Microscopic Correction - 15th Jul 17
Global Currency Reserve At Risk - 14th Jul 17
Picking Great Gold Stocks - 14th Jul 17
BBC Tree Expert's Verdict on Sheffield Amey / Labour City Council Tree Felling's - 14th Jul 17
SPX Cycles, Fed Funds and Gold - 14th Jul 17
Should Platinum Be More Expensive Than Gold? - 14th Jul 17
What's Next for US Dollar, Stocks, Bonds and Gold? - 13th Jul 17
India Gold Imports Surge To 5 Year High – 220 Tons In May Alone - 13th Jul 17
Gold and Silver: Your Stomach Is Probably Wrenching Right Now - 13th Jul 17
Gold Industry Is In A Deep State Of Dysfunction, Delusion And Denial - 13th Jul 17

Market Oracle FREE Newsletter

Crude Oil, Gold, ETFs & more: Pro-grade Market Forecasts

Valuing Cyclical Companies by Using the Price/Sales Ratio

InvestorEducation / Corporate Earnings Sep 30, 2008 - 03:55 PM GMT

By: James_Foye

InvestorEducation The price/sales multiples is one of the most often quoted investment valuation ratios. Even the legendary James O'Shaughnessy is not immune to the ratio's charms; he even went as far as to call it “the king of the value factors”. I've always found the ratio's popularity strange as the measure is dangerously flawed.


Sales represent income for both equity and debt holders: having this divided by market capitalisation means that there is a complete inconsistency between the numerator and the denominator. The logical solution would be for investors to use enterprise value to sales. Enterprise value is calculated by adding debt to market capitalisation, adjustments are also made to add in minority interest and preferred stock and also to strip out cash.

The differing results obtained from price/sales and enterprise value/sales are clearly apparent by way of an example:

 

Market Cap

Sales

Debt

Price/Sales

Enterprise Value/Sales

X € 20,000 € 100,000 € 0 0.2 0.2
Y € 20,000 € 100,000 € 50,000 0.2 0.7

X has no debt and Y is leveraged to the hilt. After operating costs, the sales from company X can be paid to shareholders or ploughed back into the business. On the other hand, Y has so much leverage that there is nothing left after interest payments. These two companies are clearly in very different financial positions, yet the price/sales ratio takes no consideration of this as it is the same for both companies. Enterprise value/sales, on the other hand, shows that company Y is significantly more expensive than company X.

The main advantages of using price/sales over price/earnings are that it can still be used for loss-making companies and sales are considered to be less subject to management manipulation than earnings. Enterprise value has both this qualities, but also squares the inconsistencies inherent in the price/sales ratio. Strangely, while enterprise value/EBITDA is used as an ancillary ratio, enterprise value/sales rarely gets the attention it deserves.

A note of caution to users of enterprise value multiples should be added. To be correct, enterprise value should be calculated using market values rather than book values. Because of the difficulty of calculating market values of bank debt, book value of debt is often used instead. While book and market values of debt are normally close, there are occasions when significant differences between the two can occur. Investors need to be aware of this when using enterprise value-based multiples.

Given the deteriorating macro economic situation the issue is particularly pertinent as more companies make losses forcing investors to place more emphasis on sales-based multiples. While no ratio can capture all information about a company, I truly believe that if investors added this ratio to their arsenal their returns will be enhanced.

By James Foye

I'm an analyst for Medvešek Pušnik in Slovenia, I'm also studying part-time for a PhD at the University of Ljubljana.

© 2008 Copyright James Foye - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

James Foye Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife