Vereit Inc (NYSE: VER) trades at a Sales Multiple of 10.4x, which is higher than the Real Estate sector median of 10.0x. While this makes VER appear like a stock to avoid or sell if you own it, you might change your mind after gaining a better understanding of the assumptions behind the EV / Sales ratio. In this article, I will break down what a Sales Multiple is, how to interpret it and what to watch out for.
Understanding Valuation Multiples and EV / Sales
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 similar public companies (peer group). We can infer if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
An Sales Multiple, also known as Enterprise Value-to-Sales Multiple (EV / Sales), 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. Furthermore, 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
A sales multiple is not meant to be viewed in isolation and is only useful when comparing it to other similar companies. Since it is expected that similar companies have similar EV / Sales ratios, we can come to some conclusions about the stock if the ratios are different. I compare Vereit’s sales multiple to those of Realty Income Corporation (NYSE: O), W.P. Carey Inc. (NYSE: WPC), Spirit Realty Capital, Inc. (NYSE: SRC) and STORE Capital Corporation (NYSE: STOR) in the chart below.
Since Vereit’s sales multiple of 10.4x is lower than the median of its peers (15.2x), it means that investors are paying less than they should for each dollar of VER’s revenue. As such, our analysis shows that VER represents an undervalued stock. In fact, finbox.io’s Sales Multiples Model calculates a fair value of approximately $9.00 per share which implies roughly 28.0% upside.
Note that the selected multiple of 11.9x in the analysis above was determined by averaging Vereit’s current sales multiple with its peer group.
Understanding the EV / Sales Ratio’s Limitations
Before jumping to the conclusion that Vereit 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 Vereit, 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 Vereit 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. In addition, revenue multiples 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, Vereit’s lower multiple may be because firms in our peer group are being overvalued by the market.
What This Means For Investors
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 VER. 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 Vereit by taking a look at the following:
Valuation Metrics: how much upside do shares of Vereit have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.
Risk Metrics: how is Vereit’s financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.
Efficiency Metrics: is management becoming more or less efficient over time? Find out by analyzing the company’s asset turnover ratio which measures the dollars in revenue a company generates per dollar of assets.
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.