What is the EV/Revenue Ratio?
The EV/Revenue ratio, or the Enterprise Value-to-Revenue ratio, is a particularly useful valuation multiple when analyzing companies that aren’t yet profitable, such as early-stage tech companies or businesses with inconsistent earnings.
By focusing on revenue, the EV/Revenue ratio offers a snapshot of how much investors will pay for each dollar of the company’s sales, regardless of the business’s current profitability.
The EV/Revenue ratio considers the company’s debt, which can give a more holistic view of a company’s valuation.
How Do You Calculate EV/Revenue?
The EV/Revenue ratio divides the business’s Enterprise Value (EV) by the company’s annual revenue:
EV / Revenue = Enterprise Value / Revenue
Where:
- Enterprise Value (EV) = Market Capitalization + Total Debt – Cash and Cash Equivalents + Preferred equity + Minority Interest
- Revenue = Total revenue reported over the past 12 months (for trailing LTM EV/Revenue) or projected revenue for the next 12 months (for forward NTM EV/Revenue).
Example Calculation:
As an example, if this was Google’s Enterprise Value and projected revenue for the next 12 months:
- Enterprise Value (EV) = $1,924 billion
- NTM Revenue = $367 billion
Then Google’s NTM EV/Revenue would be 5.2x
NTM EV/Revenue = $1,924 billion / $367 billion
NTM EV/Revenue = 5.2x
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Forward vs. Trailing EV/Revenue
The EV/Revenue ratio can be calculated on both a trailing (LTM) basis and a forward (NTM) basis. It’s important to understand the difference between these two measures:
- LTM (Last Twelve Months) EV/Revenue: This ratio uses the trailing revenue from the previous 12 months. This metric is helpful because it provides insights into how the business is valued based on actual, realized revenue.
- NTM (Next Twelve Months) EV/Revenue: This ratio uses the company’s projected or forward revenue for the next 12 months, offering a forward-looking perspective. This metric offers a glimpse into how investors are pricing in future growth expectations for a company. Generally, we prefer to use NTM figures.
Example: Google’s NTM vs. LTM EV/Revenue Ratios
Google’s LTM EV/Revenue ratio is 5.9x, based on its last twelve months of revenue totaling $328.3 billion. In contrast, Google’s NTM EV/Revenue ratio is 5.3x, based on Google’s projected revenue for the next 12 months of approximately $367.1 billion:
Since analysts expect that Google’s revenue will grow next year, Google has a lower NTM EV/Revenue ratio than its LTM ratio, making the company look relatively more affordable on a forward-looking basis.
We generally prefer to use NTM valuation multiples because examining a company’s next 12-month estimates helps investors to better evaluate a company’s valuation based on its future growth expectations.
What is a Good EV/Revenue?
Determining what constitutes a “good” EV/Revenue ratio depends on several factors, including the company’s profitability, industry, growth prospects, and current market conditions. Here are some factors that impact a company’s EV/Revenue ratio:
- Industry Comparison: In some sectors, such as technology or pharmaceuticals, companies might have high EV/Revenue ratios due to high growth expectations. For example, a tech company with an EV/Revenue ratio of 10 might be considered reasonably valued if it’s rapidly growing its revenue. On the other hand, in more stable, low-growth industries like utilities, an EV/Revenue ratio of 3 might be considered high.
- Growth Expectations: A higher EV/Revenue ratio often implies that the market expects significant revenue growth. A high ratio might be justified if the company is expected to dominate its market and grow its revenue significantly.
- Profitability: Companies with higher profitability often command higher EV/Revenue ratios because they generate more income from each dollar they make in revenue. When a company consistently delivers strong profit margins, investors are typically willing to pay a premium, leading to a higher EV/Revenue multiple. Conversely, companies with lower profitability might trade at lower EV/Revenue multiples.
- Economic Cycle: The EV/Revenue ratio changes with the market’s ups and downs. The ratio usually rises in bull markets because investors are generally willing to pay more for stocks. On the other hand, the ratio tends to drop during bear markets as investors lose confidence and approach stocks with more caution.
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How the EV/Revenue Ratio Tells Investors if a Stock is Over/Undervalued
The EV/Revenue ratio can be a valuable tool for determining whether a stock is overvalued or undervalued:
Overvalued:
- If a stock has a significantly higher EV/Revenue ratio than its 5-year average or compared to its industry peers, it may be overvalued, especially if its revenue or margin growth doesn’t justify trading at a premium. This high ratio often assumes the company can sustain or accelerate its revenue growth, but if it fails to meet these expectations, the stock price could drop significantly.
Example: Suppose a company in the healthcare sector has an EV/Revenue ratio of 15x, while its peers average around 5x. If the company’s revenue growth rate is in line with or lower than its peers and has similar margins, this could indicate that the stock is overvalued, as the market may be pricing in unrealistic growth expectations.
Undervalued:
- If a stock has a lower EV/Revenue ratio than its 5-year average or its industry peers, it might be undervalued, especially if it has strong revenue growth prospects, margin growth prospects or operates in an industry with high barriers to entry. Additionally, companies in cyclical industries often have low trailing ratios during downturns, presenting attractive opportunities for investors anticipating a market rebound.
Example: Consider a software company with an EV/Revenue ratio of 4x, while its competitors have an average ratio of 10. If this company is expected to see decent revenue growth and profitability compared to its peers, the low ratio might indicate that the stock is undervalued.
What is a High EV/Revenue Ratio?
A “high” EV/Revenue ratio is relative, as it varies across industries and depends on a company’s growth expectations and profitability. However, a stock might be overvalued if it is trading well above its 5-year average EV/Revenue multiple or if its multiple has increased significantly in the past year without a corresponding increase in growth or profitability. If the company is priced significantly higher than its usual valuation levels without an increase in growth or profitability expectations, the stock may be overvalued.
What is a Low EV/Revenue Ratio?
Again, it’s difficult to pinpoint a “low” EV/Revenue ratio because different stocks naturally trade at different ratios depending on their expected growth, profitability, and more. However, it’s generally a sign that a company might be undervalued if a stock has strong profitability and growth forecasts, but the company is trading below its 5-year or 1-year average EV/Revenue multiple. This might indicate that the company is more undervalued than usual.
FAQs
Why is EV/Revenue used for valuing companies?
EV/Revenue is commonly used to value companies because it accounts for both equity and debt, giving a fuller picture of a company’s valuation. It’s particularly useful for companies that are not yet profitable, such as tech startups, where earnings metrics may not be as relevant.
What is the difference between EV/Revenue and Price/Sales ratio?
EV/Revenue includes both equity and debt in its calculation, reflecting the total value of the business, whereas Price/Sales only considers the equity portion. EV/Revenue is considered more comprehensive, especially for companies with varying capital structures.
Can EV/Revenue be negative?
EV/Revenue is rarely negative, since revenue is almost always a positive number. However, the ratio could technically be negative if a company has a negative enterprise value, which can occur when cash exceeds the company’s market value and debt.
What industries use EV/Revenue the most?
EV/Revenue is often used in industries where companies may not yet be profitable, such as technology, biotech, and early-stage startups. It’s particularly useful for comparing high-growth companies that reinvest heavily in expansion, making traditional earnings-based ratios less relevant.
How does EV/Revenue relate to company growth?
A higher EV/Revenue ratio can indicate that investors expect higher future growth from the company, as they are willing to pay more for each dollar of revenue. However, it’s important to assess whether the growth prospects justify the valuation, as high ratios can sometimes signal overvaluation.
TIKR Takeaway
The EV/Revenue ratio is a helpful valuation metric showing how much investors pay for each dollar of a company’s revenue.
This ratio is particularly useful for evaluating companies with varying profitability, such as early-stage tech stocks.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold positions in any of the stocks mentioned in this article. Thank you for reading, and happy investing!
