31st December 2009, 09:14 AM
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Sachin Asher
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Join Date: Sep 2006
Location: Vadodara
Posts: 8,621
Rep Power: 383
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I don't really think "Market cap to sales" ratio has much use.
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Firstly, the equity of a company gets its value from the profit that it makes and not from the sales that the company achieves.
If I set-up a business and start selling gold at 3% discount to the market price, I can generate sales of millions of dollars.
Will this business have any value?
No.
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Profits from the same amount of sales, can vary vastly from sector to sector.
An IT company may be making 3000 crore of PAT from sales of 10000 crore.
At the same time, a textile company may be making only 300 crore of PAT from sales of 10000 crore.
The market capitalization of the IT company would be much greater than the market capitalization of the textile company - in spite of the fact that both companies have the same sales value.
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Even if the companies are in the same sector and have the same turnover, the PAT figure may be very different.
Suppose a company ABC has sales of 5000 crore, an EBITDA of 1000 crore and zero debt. The final PAT figure is around 500 crore.
Another company XYZ in the same sector, has sales of 5000 crore and also has an EBITDA of 1000 crore.
However, XYZ has a debt of 3000 crore and an annual interest outflow of 300 crore. PAT for XYZ is only around 250 crore.
If the market gives the same PE to both companies, the "market cap to sales" ratio for XYZ would be half that of ABC.
This won't mean XYZ is undervalued compared to ABC.
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The biggest drawback of this ratio is that it is comparing apples and oranges.
I will post more later....
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