Relative Valuation II. - InvestMentor

P/S Ratio

The price-to-sales ratio compares a company’s stock price to its revenue (sales) per share.

P/S = market price / revenue per share

This metric is useful for evaluating firms with little or no earnings — like startups or those in downturns. P/E ratio tends to be more popular, but it's meaningless if the company's not profitable.

A lower P/S may suggest undervaluation; a higher one could signal overvaluation. This ratio helps investors see how much they’re paying for each dollar of a company’s sales.

P/B Ratio

The price-to-book (P/B) ratio measures a company's market value relative to its book value. Calculated as:

P/B = share price / book value per share

This ratio is significant for asset-intensive industries like manufacturing, energy, or banking. A P/B ratio below 1 may signal that the stock is undervalued compared to its assets, while a ratio above 1 could indicate overvaluation.

Investors use the P/B ratio to assess whether the market price accurately reflects the company's net asset value.

Daniel’s Choice of EV/EBITDA

After gathering market data on RetailChain and its competitors, Daniel analyzes the valuation multiples.

Noticing that depreciation and amortization significantly affect net income in the retail sector, he opts to use the EV/EBITDA ratio for a clearer picture of operational performance.

The average EV/EBITDA among the comparables is 8x.

With RetailChain Inc. having an EBITDA of $2,000,000, he estimates its enterprise value as:

Estimated Enterprise Value = 8 x $2,000,000 = $16,000,000

Applying Multiples to Estimate Value

Let’s break down the value step by step.

To figure out what a company might be worth, take its earnings, EBITDA, or sales, and multiply by the average numbers used to value similar companies — known as comparables or comps.

Each metric gives a different angle:

Earnings for profitability
EBITDA for operations
Sales for top-line strength

Stack these estimates against the company’s current market value to spot potential undervaluation or red flags.

Operational Adjustments for Profitability

When comparing companies, differences in profitability can distort valuation.

Metrics like profit margins, return on equity, and efficiency ratios affect how multiples should be interpreted.

A firm with higher profit margins may well deserve a higher P/E ratio than its peers. A high ratio does not automatically mean the stock is overvalued.

Operational adjustments help investors make fair comparisons and better estimate a company’s value based on its operational performance.