Enterprise Value-to-Revenue (EV/R) Ratio: Definition, Calculation, and Real-Life Applications
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Summary:
The enterprise value-to-revenue multiple (EV/R) is a vital financial metric that compares a company’s enterprise value to its revenue, helping investors determine a stock’s fair pricing and its use in potential acquisitions. This article delves into the concept, calculation, real-life examples, and its comparison with EV/EBITDA. Learn how to utilize EV/R and its limitations. Discover how to compute EV/R, and why it’s valuable even for companies without profits.
What is the enterprise value-to-revenue multiple (EV/R)?
The enterprise value-to-revenue multiple (EV/R) is a crucial financial metric that assesses a company’s value by comparing its enterprise value to its revenue. This metric, also known as the enterprise value-to-sales multiple, plays a pivotal role in helping investors gauge whether a stock is reasonably priced. Moreover, it serves as a valuable tool when assessing a company’s worth in the context of a potential acquisition.
Understanding the enterprise value-to-revenue multiple (EV/R)
The enterprise value-to-revenue (EV/R) multiple provides a critical comparison between a company’s revenue and its enterprise value. This metric is based on a simple premise: the lower the EV/R, the more undervalued the company appears. It is primarily used as a valuation multiple, with frequent applications during the process of acquisitions.
When a potential acquirer is considering purchasing a company, they rely on the EV/R multiple to establish a fair and appropriate value. What sets this metric apart is its consideration of the enterprise value, which factors in debt and cash. An acquirer takes on the debt and receives the cash, making EV/R a comprehensive assessment of the company’s worth.
How to calculate the enterprise value-to-revenue multiple (EV/R)
Calculating the enterprise value-to-revenue (EV/R) multiple is a straightforward process. You take the enterprise value of the company and divide it by the company’s revenue:
Here’s the formula for calculating EV/R:
EV/R = Enterprise value / Revenue
Where:
- Enterprise value = Market capitalization + Debt – Cash and cash equivalents
- Market capitalization (MC) represents the market value of a company’s outstanding shares.
- Debt (D) signifies the company’s outstanding debt obligations.
- Cash and cash equivalents (CC) encompass the cash holdings of the company.
In a practical example, let’s consider a company with the following financials:
- $20 million in short-term liabilities
- $30 million in long-term liabilities
- $125 million in assets, of which 10% is in cash
- 10 million common stock shares outstanding, priced at $17.50 per share
- Reported revenue of $85 million in the past year
Using these numbers, the enterprise value would be calculated as follows:
Enterprise value = ($10,000,000 x $17.50) + ($20,000,000 + $30,000,000) – ($125,000,000 x 0.1) = $175,000,000 + $50,000,000 – $12,500,000 = $212,500,000
Next, to find the EV/R, you simply divide the enterprise value by the revenue for the year:
EV/R = $212,500,000 / $85,000,000 = 2.5
It’s crucial to note that enterprise value can also be calculated using a more comprehensive formula that includes additional variables such as preferred shared capital (PSC) and minority interest (MI). Some analysts prefer this method when assessing enterprise value.
Example of how to use the enterprise value-to-revenue multiple (EV/R)
Let’s take a real-life example from the major retail sector, considering companies like Wal-Mart, Target, and Big Lots. As of August 15, 2020, their enterprise values are $433.9 billion, $79.33 billion, and $3.36 billion, respectively.
Meanwhile, their revenues over the trailing 12 months amount to $534.66 billion, $80.1 billion, and $5.47 billion, respectively. When you divide their enterprise values by revenues, you get the following EV/R ratios:
- Wal-Mart: EV/R = 0.81
- Target: EV/R = 0.99
- Big Lots: EV/R = 0.61
This analysis showcases how EV/R can provide valuable insights into the relative valuation of different companies within the same industry.
The difference between enterprise value-to-revenue multiple (EV/R) and enterprise value-to-EBITDA (EV/EBITDA)
The enterprise value-to-revenue multiple (EV/R) focuses on a company’s revenue-generating capability, whereas the enterprise value-to-EBITDA (EV/EBITDA), also known as the enterprise multiple, assesses a company’s ability to generate operating cash flows. EV/EBITDA takes into account operating expenses, providing a more in-depth evaluation than EV/R.
An advantage of EV/R is its applicability to companies that have not yet generated income or profits, such as Amazon during its early years.
Limitations of using enterprise value-to-revenue multiple (EV/R)
While the enterprise value-to-revenue multiple (EV/R) is a valuable tool for comparing companies within the same industry, it has limitations:
- It is most useful when comparing companies in the same industry to understand if a ratio represents strong or weak performance.
- Unlike market capitalization, which is readily available, calculating the EV/R multiple requires determining the enterprise value, which can involve complex elements like debt and cash.
Frequently asked questions
What is the significance of a lower EV/R multiple?
A lower EV/R multiple suggests that a company is potentially undervalued, making it an attractive prospect for investors or acquirers.
Can EV/R be used for companies without profits?
Yes, EV/R can be applied to companies that do not generate income or profits, as it assesses a company’s value based on its revenue, which is not dependent on profitability.
How does EV/R differ from EV/EBITDA?
EV/R focuses on a company’s revenue-generating ability, while EV/EBITDA assesses a company’s ability to generate operating cash flows and includes considerations of operating expenses.
What industries benefit the most from using the EV/R multiple?
The EV/R multiple is particularly valuable for industries where revenue plays a significant role in evaluating performance, such as the retail and technology sectors.
Key takeaways
- The enterprise value-to-revenue multiple (EV/R) measures a company’s value relative to its revenue.
- It aids in determining a company’s valuation in the case of potential acquisitions.
- EV/R is applicable even for companies that do not generate income or profits.
- Calculating EV/R involves dividing the enterprise value by the company’s revenue, with the enterprise value including market capitalization, debt, and cash.
- Real-life examples, such as those from the retail sector, illustrate how EV/R can provide insights into a company’s relative valuation within an industry.
- EV/R differs from the Enterprise Value-to-EBITDA (EV/EBITDA) ratio, with the former focusing on revenue-generating ability and the latter assessing cash flow generation.
- While EV/R is a useful tool, it’s most effective when comparing companies in the same industry, and it requires more complex calculations than readily available metrics like market capitalization.
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