Best Buy Co Inc (NYSE: BBY), a consumer discretionary company with a market capitalization of $20.6 billion, currently trades at a Sales Multiple of 0.5x which is below the sector’s median multiple of 1.2x. Although this makes BBY look attractive, investors may change their mind after reviewing the assumptions behind the EV / Sales ratio. In the post below, I calculate Best Buy’s fair value using a Sales Multiples valuation.
How To Interpret Best Buy’s Sales Multiple
A multiples valuation, also known as a comparable companies analysis, determines the value of a subject company by benchmarking the subject’s financial performance against companies deemed to be similar. We can then determine if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
EV / Sales, also known as Enterprise Value-to-Sales Multiple or a Sales Multiple, measures the dollars in Enterprise Value for each dollar of revenue. Its key benefit over the P/E multiple is that it’s capital structure-neutral, and, therefore, better at comparing companies with different levels of debt. 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 Best Buy’s EV / Sales ratio to its peer group that includes Lowe’s Companies, Inc. (NYSE: LOW), Home Depot, Inc. (The) (NYSE: HD), AutoZone, Inc. (NYSE: AZO) and Williams-Sonoma, Inc. (NYSE: WSM).
Since Best Buy’s EV / Sales ratio of 0.5x is lower than the median of its peers (1.6x), it means that investors are paying less than they should for each dollar of BBY’s revenue. As such, our analysis shows that BBY represents an undervalued stock. Furthermore, finbox.io’s EV / Sales Ratio Model calculates a fair value of $163.80 per share which implies huge upside.
I selected a fair multiple of 1.1x in my analysis by averaging Best Buy’s current EV / Sales ratio with its peer group and sector.
Sales Multiple Flaws
While this approach typically provides a reasonable valuation range, it is important to understand that our conclusion rests on some important assumptions. The first being that the selected peer group actually contains companies that truly are similar to Best Buy. The second important assumption is that the selected peer group stocks are being fairly valued by the market.
If the assumptions above do not hold to be true, then the difference in EV / Sales ratios could be due to a variety of factors. For example, if you accidentally compare Best Buy with higher growth companies, then its sales multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price. Furthermore, sales multiples are highly correlated with EBITDA margins so differences in profit margin often explain differences in valuation.
source: sales multiples model
Now if the second assumption does not hold true, Best Buy’s lower multiple may be because firms in our peer group are being overvalued by the market.
What To Do Next
As a current investor, you may have already conducted fundamental analysis on the company and its stock so its current undervaluation could signal a potential buying opportunity to increase your position in BBY. But keep in mind the EV / Sales ratio’s potential flaws when applying this valuation approach. It is important to note that there are a variety of other fundamental factors that I have not taken into consideration in this article. I highly recommend that you continue your research on Best Buy by taking a look at the following:
Valuation Metrics: how much upside do shares of Best Buy have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.
Risk Metrics: what is Best Buy’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.
Efficiency Metrics: how much free cash flow does Best Buy generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
Author: Brian Dentino
Expertise: financial technology, analyzing market trends
Brian is a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to research stock fundamentals. Brian’s background is in physics & computer science and previously worked as a software engineer at GE Healthcare. He enjoys applying his expertise in technology to help find market trends that impact investors.
Brian can be reached at email@example.com.
As of this writing, Brian did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.