Pebblebrook Hotel Trust (NYSE: PEB) shares currently trade at 4.1x its trailing revenue which is lower than the Real Estate sector median of 10.0x. While this makes PEB look like a stock to add to your portfolio, equity investors might change their mind after taking a closer look at the assumptions behind the EV / Sales ratio. In this article, I define how to calculate a Sales Multiple and what to keep an eye out for when applying it in a comparable companies analysis.
Pebblebrook Hotel Comparable Companies Analysis
A comparable companies analysis, also known as a multiples valuation, determines the value of a subject company by benchmarking its financial performance against similar public companies or peers. We can conclude if a company looks undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation ratios.
Enterprise Value-to-Revenue Multiple, also known as the EV / Sales ratio or a Sales Multiple, measures the dollars in Enterprise Value for each dollar of revenue. To determine if a company is expensive, it’s far more useful to compare EV / Sales multiples than the absolute stock price. The general formula behind a Sales Multiples valuation model is the following:
Enterprise Value = Revenue x Selected Multiple
The EV / Sales ratio by itself is not very helpful at all. It is only useful when comparing it to other companies that are considered similar to the subject company. The basic idea is that companies with similar characteristics should trade at similar multiples, all other things being equal. Therefore, we can come to a conclusion about the stock if the ratios are different. In the chart below, I compare Pebblebrook Hotel’s EV / Sales ratio to its peer group that includes Diamondrock Hospitality Company (NYSE: DRH), LaSalle Hotel Properties (NYSE: LHO), Sunstone Hotel Investors, Inc. (NYSE: SHO) and Hersha Hospitality Trust (NYSE: HT).
Since Pebblebrook Hotel’s sales multiple of 4.1x is higher than the median of its peers (3.5x), it means that investors are paying more than they should for each dollar of PEB’s revenue. As such, our analysis shows that PEB represents an overvalued stock. In fact, finbox.io’s Sales Multiples Model calculates a fair value of $27.44 per share which implies -17.4% downside.
I selected a fair multiple of 3.6x in my analysis by averaging Pebblebrook Hotel’s current EV / Sales ratio with its peer group.
Are Comps Really Comparable?
Before concluding that Pebblebrook Hotel should be banished from your portfolio, it is important to understand that our conclusion rests on two important assumptions.
(1) the selected peer group actually contains companies that truly are similar to Pebblebrook Hotel, and
(2) the selected peer group stocks are being fairly valued by the market.
If the first assumption is not accurate, the difference in sales multiples could be due to a variety of factors. For example, if you accidentally compare Pebblebrook Hotel with lower growth companies, then its sales multiple would naturally be higher than its peers since investors reward high growth stocks with a higher price. It’s also important to note that EV / Sales ratios are highly correlated with profit margins so differences in EBITDA margin often explain differences in valuation.
source: sales multiples model
Now if the second assumption does not hold true, Pebblebrook Hotel’s higher multiple may be because firms in our peer group are being undervalued by the market.
How This Impacts Shareholders
As a shareholder, you may have already conducted fundamental analysis on the stock so its current overvaluation could signal a potential selling opportunity to reduce your exposure to PEB. However, keep in mind the limitations of a sales multiples valuation when making an investment decision. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on Pebblebrook Hotel by taking a look at the following:
Valuation Metrics: what is Pebblebrook Hotel’s free cash flow yield and how does it compare to its publicly traded peers? This metric measures the amount of free cash flow for each dollar of equity (market capitalization). Analyze the free cash flow yield here.
Risk Metrics: what is Pebblebrook Hotel’s cash ratio which is used to assess a company’s short-term liquidity. View the company’s cash ratio here.
Efficiency Metrics: return on equity is used to measure the return that a firm generates on the book value of common equity. View Pebblebrook Hotel’s return on equity here.
Author: Matt Hogan
Expertise: Valuation, financial statement analysis
Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock.
Matt can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.