Understanding Revenue Based Stock Valuation

There are many different ways to look at a company to determine if it will be a good investment. While price per share earnings are one of the most common types of revenue based stock valuation, there are times when a company may not report positive earnings due to high tax burdens, expansion costs, and other expenses. Even when this is the case, the company still produces revenue during day to day operations. Understanding some of the methods used for valuation will help you to identify the best investments.

In order to assess a real revenue based valuation, one must take a look at the price/sales ratio. This is calculated using the company’s market capitalization, a figure that is equal to the current market price of stock in the company multiplied by the number of shares outstanding. In other words, if the current share price of the company’s stock is 100 rupees and there are 1 million outstanding shares, the market capitalization would be 100 times 1 million equals 100 million rupees.

Conservative investors would then add the company’s long term indebtedness total to the current market value of the company to arrive at a more accurate figure for market capitalization. If the company mentioned above has just taken on a long term debt of 50 million rupees, this figure would be added to the 100 million rupees in share value to get a total market capitalization of 150 million rupees. This approach makes it possible to avoid getting false comparisons between two different companies when one has a huge debt and the other is debt free, even if sales are lower.

The next figure needed would be the company’s trailing revenue for the past year. This can be arrived at by looking at quarterly reports and adding the revenue reported for each of the last four quarters together.

Calculating the price/sales ratio is then a simple matter of performing the maths. Let’s assume that the company we are using as an example had revenue of 300 million rupees over the last four quarters. If we take the current market capitalization of 150 million rupees and divide it by the revenue of 300 million rupees, we arrive at a P/S ratio of 0.5. As with the P/E ratio, the lower this ratio is, the better the odds that this will prove to be a good investment.

Making use of the P/S ratio and P/E ratio to evaluate the same corporation can confirm whether it is a sound investment. A company with a low P/E and a high P/S can mean that one time gains during the last year have pumped up the earnings per share with no guarantee that such will occur again.