Life Storage Inc (NYSE: LSI) shares currently trade at 11.1x its trailing revenue which is higher than the Real Estate sector median of 10.0x. While this makes LSI look like a stock to avoid or sell if you own it, 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.
Life Storage 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 Life Storage’s EV / Sales ratio to its peer group that includes CubeSmart(NYSE: CUBE), Extra Space Storage Inc (NYSE: EXR), National Storage Affiliates (NYSE: NSA) and Public Storage (NYSE: PSA).
Since Life Storage’s sales multiple of 11.1x is lower than the median of its peers (13.7x), it means that investors are paying less than they should for each dollar of LSI’s revenue. As such, our analysis shows that LSI represents an undervalued stock. In fact, finbox.io’s Sales Multiples Model calculates a fair value of $111.54 per share which implies 26.1% upside.
I selected a fair multiple of 13.0x in my analysis by averaging Life Storage’s current EV / Sales ratio with its peer group.
Are Comps Really Comparable?
Before concluding that Life Storage should be added to 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 Life Storage, 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 Life Storage 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. 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, Life Storage’s lower multiple may be because firms in our peer group are being overvalued by the market.
How This Impacts Shareholders
As a shareholder, you may have already conducted fundamental analysis on the stock so its current undervaluation could signal a potential buying opportunity to increase your position in LSI. 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 Life Storage by taking a look at the following:
Valuation Metrics: how much upside do shares of Life Storage 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 Life Storage’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 Life Storage generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
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.