Investment Opinion
FOOL PLATE
SPECIAL
Enterprise Value -- An Introduction
I have written some articles on the Price/Sales Ratio (PSR) lately and wanted to let you know about some modifications that actually better reflect the underlying value in a particular company. To recap for those who have not read the Price/Sales Ratio columns, the PSR is a valuation that measures the revenues generated by a firm versus its current market capitalization. If Harry's Handgrenades <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BOOM)") else Response.Write("(NASDAQ: BOOM)") end if %> has 10 million shares outstanding, a current share price of $10, and trailing sales from fiscal year 1996 of $100 million, the Price/Sales Ratio goes as follows:
------- = ----------------- = ---------------------------------
Sales Last 4 Q Rev. Last 4 Q Rev.
10 M shares * $10/share $100 M
PSR = ------------------------------ = ------------ = 1.0
$100 M revenues $100 M
The reason why the Price/Sales Ratio is relevant is that it directly translates into a Price/Earnings Ratio if you have an idea about what future profit margin will be. Thus, for a company that temporarily has no earnings but that you expect will turn itself around, the Price/Sales Ratio gives you a way to value it. Cool, right? Right.
The guidelines for what makes a good Price/Sales Ratio are both complicated and simple. First off, you want it to be as low as possible -- with the caveat that normally the two or three cheapest companies in any group are often cheap for a reason. I have learned the hard lesson of not buying the cheap one more than once in the last few months, as more often than not the cheap one ends up stating a month later that business is all messed up and that they will not be making any money for the next six years.
As a general rule, if you have a Price/Sales Ratio of 0.75 or under, you are doing fine. If the Price/Sales Ratio is under 1.25 or so, you can get away with it if you anticipate the company is going to have after-tax profit margins of 10% or more. Anywhere above 3.0 and you are starting to get into the stratosphere, unless you have an absolutely freakish company with 20% or better after-tax margins. Tonight's Fool On the Hill in the Evening News will use this discussion of Price/Sales Ratios to teach you what Enterprise Value really is.
SUN MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SUNW)") else Response.Write("(NASDAQ: SUNW)") end if %> benefited $2 3/8 to $58 1/4 from a Goldman Sachs upgrade today. Goldman moved the computer equipment and software company from its "Recommended" list to its "Priority" list.
Computer-integrated measurement, control, and information services company EASUREX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MX)") else Response.Write("(NYSE: MX)") end if %> reported record earnings, beating estimates by a penny and gaining $5/8 to $28 3/8.
HEILIG-MEYERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HMY)") else Response.Write("(NYSE: HMY)") end if %> was added to Goldman Sachs's "Recommended" list today, with shares rallying $7/8 to $22 1/8.
Oppenheimer & Co. initiated coverage of ROCK BOTTOM RESTAURANTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BREW)") else Response.Write("(NASDAQ: BREW)") end if %> with a "buy" rating, sending shares up $7/8 to $14.
Alex. Brown started covering INTEGON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IN)") else Response.Write("(NYSE: IN)") end if %> with a "buy" rating. Shares of the insurance holding company rose $3/4 to $20.
NEUOCRINE BIOSCIENCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NBIX)") else Response.Write("(NASDAQ: NBIX)") end if %> shares jumped $7/8 to $12 after Robertson Stephens started the pharmaceutical company as a "buy".
Software development company SEER TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SEER)") else Response.Write("(NASDAQ: SEER)") end if %> saw its shares soar $1 3/8 to $8 1/2 after yesterday's agreement to jointly market products with HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>.
Perhaps benefiting from VALUJET's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VJET)") else Response.Write("(NASDAQ: VJET)") end if %> woes, USAIR GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: U)") else Response.Write("(NYSE: U)") end if %> rose $3/4 to $18 3/4.
LATTICE SEMICONDUCTOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LSCC)") else Response.Write("(NASDAQ: LSCC)") end if %> unraveled $8 1/8 to $26 1/8 after warning that first quarter earnings would fall 8% to 10% below year-ago levels. The company blamed pricing pressures and customers overstocking for the disappointment.
VALUJET <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VJET)") else Response.Write("(NASDAQ: VJET)") end if %> shares dropped sharply $5 1/2 to $4 1/2 after the FAA grounded the airline on safety concerns.
LCD projection product specialist IN FOCUS SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: INFS)") else Response.Write("(NASDAQ: INFS)") end if %> plunged $4 7/8 to $29 after warning that its second quarter operating income will be lower than expected.
Flexible circuit concern ADFLEX SOLUTIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AFLX)") else Response.Write("(NASDAQ: AFLX)") end if %> also warned of significantly disappointing upcoming earnings, and paid for it with a $2 3/4 to $9 3/4 drop.
Randy Befumo (MF Templar), a
Fool
Selena Maranjian (MF Selena),
another Fool