# Price to Sales ratio and EV/Sales ratio (Case study: share value analysis for Deliveroo, Just Eat and Delivery Hero)

## Definition of Price to Sales Ratio (PSR or PS ratio)

PS ratio (PSR, Price to Sales Ratio) is a sales multiple in the relative valuation method. It tells how many times the share price to its sales of \$1 is.

For example, if firm A’s sales are \$100m and its market cap (total market value of equity capital) is \$300m, it means investors pay three times its sales for A’s stocks. You can get PSR (Price to Sales Ratio) by dividing the market cap by the sales revenue.

#### Price to sales ratio = Market cap / Sales revenue

If you use EV (Enterprise Value) in the numerator of the PS ratio formula instead of market cap, you can get a more robust multiple, EV/Sales ratio. EV/Sales ratio (Enterprise Value to Sales Ratio) refers to the total firm value per the sales of \$1.

#### EV/Sales ratio = EV / Sales revenue

EV = Total market value of stocks + Total market value of financial debts – Cash or cash equivalents

It is easy to understand the differences between the Price to Sales Ratio and the EV/Sales ratio. Let’s say that firm A and firm B have the same sales revenue of \$100m both. While A has \$100m of equity capital without financial debts, B has only \$20m of equity capital and \$80m of financial obligations. In this case, A’s PSR (Price to Sales Ratio) is 1.0, and B’s is 0.2.

When using the EV/Sales ratio, both A and B have 1.0. That is why EV/Sales ratio has a more robust result from the perspective of total capital. Firm A has a large amount of borrowing, so it has a lower PS ratio. Therefore, comparing the PSR (Price to Sales Ratio) across companies with various leverage levels could lead you to misjudgement.

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## Pros and cons of Price to Sales Ratio

There are reasons analysts and investors prefer the PSR (Price to Sales Ratio).

1. First, you can apply PSR (Price to Sales Ratio) to companies whose sales are growing, but incomes are still in the red. Venture companies and high-growth companies may fall into this category.
2. Second, accounting standards applied to depreciation expenses, inventory assets, and R&D expenses affect the size of profits and net assets but relatively less affects sales. Therefore, PSR (Price to Sales Ratio) is robust on accounting standards compared to PER or PBR.
3. Third, profits may be volatile, but sales are relatively stable. Therefore, while PER could be highly volatile every year, PSR (Price to Sales Ratio) would provide a relatively stable multiple.

##### However, the PSR (Price to Sales Ratio) would have a big problem: even companies that have been eroded in capital or have sustained deficits may show high value if their sales are significant.

Therefore, you need to analyse whether that company’s profits would turn into a surplus when applying a PSR (Price to Sales Ratio) to companies with negative profits or minus net assets. You need to use different valuation methods for those companies when you consider them that they would not be able to escape from deficits or capital impairment in the long term.

## Case analysis 1: Comparison of PS ratio between Just Eat and Delivery Hero

Just Eat and Delivery Hero are major European food delivery services companies.

Just Eat is headquartered in London, UK and operates in other 13 countries. It was listed on the London Stock Exchange in February 2020.

Delivery Hero is headquartered in Berlin, Germany and listed on the German Stock Exchange, and operates in other 40 countries, including Asia and the Middle East. The company also operates ‘Yogiyo’ and ‘Delivery box’ in Korea and is also active in the M&A activities.

The primary market data and fundamental elements of the two companies are as follows.

Comparison of the PS ratio between Just Eat and Delivery Hero (Source: Yahoo Finance)

The market cap of Just Eat and Delivery Hero is £12.5b and €18.3b respectively as of Sep 2020. The Price to Sales Ratio is similar, 10x and 11x, respectively. The EV/Sales multiple is 13.8x and 10.4x each, where Just Eat is slightly higher.

Let’s look at the net margin and operating margin to analyse their share prices more closely. Both profit margins are all in the red, but Just Eat is -15.5%, and Delivery Hero is -55.8%. Just Eat’s deficit is smaller. In terms of operating margin, Just Eat is 0%, and Delivery Hero -51.4%. Just Eat’s margin is better than Delivery Hero’s.

##### The PS ratio multiples of Just Eat and Delivery Hero are similar, but you will realise that Delivery Hero is overvalued compared to Just Eat when analysing the fundamentals together.

As for the EV/Sales ratio, it might seem difficult to say that Just Eat is more overvalued than Delivery Hero because Just Eat’s margin ratio is better than Delivery Hero’s. Let’s use only their income statements to see whether the two companies’ margin could improve in the future.

Just Eat and Delivery Hero’s profit and loss indicators (Source: Yahoo Finance)

Just Eat and Delivery Hero’s sales have grown at a similar level over the past four years. Both companies’ sales in 2019 increased by about four times compared to four years ago. Just Eat’s operating loss rate has gradually decreased over the past four years. Delivery Hero’s operating margin also seemed to improve for a while, but it plunged to -51.4% in 2020, so we cannot predict its direction at ease for the following year. In 2019, its net profit was in the black, but the operating profit was a loss. It seems that it came from non-recurring items.

Considering the possibility of the profit margin improvement in the future, judged solely by the trends, Delivery Hero’s share price seems overvalued compared to Just Eat.

## Case Analysis 2: Valuation of Deliveroo using the Price to Sales Ratio

Using the PS ratio or the EV/Sales multiple, you can evaluate the share value or the enterprise value of companies with a high sales growth rate when their profit margins are expected to improve.

When companies’ sales are increasing, you can use the estimated sales in the future to value their stock prices. The calculation process is as follows.

• Forecast sales in the future.
• Use the PSR (Price to Sales Ratio) or EV/Sales ratio of the peer group to estimate the future share value of the target company.
• Convert it to the present share value.

Let’s evaluate the share value of Deliveroo, another food delivery service company, using Just Eat and Delivery Hero as comparable companies.

Deliveroo is a food delivery service company founded in 2013 and headquartered in London. It operates in 200 cities in the UK, EU counties, the Middle East, Australia, Singapore, and Hong Kong. Deliveroo’s sales grew from £277m in 2017 to £476m in 2019, totally 72% growth rate and annually 31%.

• If its sales would grow at an annual average rate of 15% over the next five years, Deliveroo’s sales would reach £951m in 2024.
• The average PSR (Price to Sales Ratio) of Just Eat and Delivery Hero is 10.46. Deliveroo’s share value could be calculated in 5 years as follows.

Share value in 5 years = £951 m x 10.46 = £9,947m

• You need Deliveroo’s cost of equity capital to convert its future share value to the present value. Using the UK’s risk-free interest rate, the FTSE market premium, and the betas of Just Eat and Delivery Hero, Deliveroo’s equity cost is 5.05% (= 0.19% + 0.65 x 7.47%).

So, you can calculate the current stock value as follows.

Deliveroo’s current share value = £9,947 m / (1+ 5.05%)5 = £7,775 m

Deliveroo’s share value is evaluated at around £7.8b. The reason for using estimated future sales is to reflect the potential growth into present value when judging that its growth is apparent. When valuing its share price with the recent sales, it is about £5.0 b (= £476 m x 10.46).

It is advantageous for investors to purchase Deliveroo’s shares at the value of £5.0b. On the other hand, if Deliveroo’s existing equity-holders think that the growth seems obvious, they should raise funds by reflecting the future growth rate into the present value.