Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Security Analysis-II - Question Paper

Next 10 years
After 10 years

Payout ratio
22
45

Sales/book value
2
–

Expected growth
7.8%
5%

Cost of equity
11.275%
11.275%

Profit margin
5
5

Beta
1.05
1.05


Ke = 5.5 + 1.05*5.5 = 11.275%

Expected growth rate for the Industry = (1 – Payout ratio) * Profit margin * Sales to book value ratio

= (1 – 0.22) * 0.05 * 2

= 0.078 i.e. 7.8%

Price to sales ratio can be obtained out from the subsequent formula:

Price to Sales ratio =

= 0.08[7.3382]

= 0.5871

Now, Sales per share for the company is Rs.76.03

Therefore Price for the company is 76.03 0.5871 = Rs.44.64
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4.
When analyzing companies, sometimes price-to-sales ratio is of little help in understanding how a company is really valued by the market. There are 2 main reasons against the Price to sales ratio for being a contrary indicator

1. Not all sales dollars are created equal.

a few sales come with a high degree of profitability, while a few only bring pennies on the rupees invested. Let's take a real-world example of grocery store company versus software behemoth. Take a look at every company's margins:

Company
Grocery store
Software

Gross Margin
86.9%
24.4%

Oper. Margin
47.6%
4.8%

Net Margin
41.0%
1.4%


It should be painfully obvious that every dollar in sales that Software company brings in is much more valuable (about 30x more valuable!) than every dollar in sales that Grocery store brings in. Comparing price to sales ratio on an apples-to-apples basis is not a good idea because the sales of 2 various companies mean entirely various things to the bottom line and, ultimately, to the cash flow-generating capability of every. In the end, Price to Sales Ratio figures would differ greatly. Any talk of sales figures without a concurrent talk of margins is useless.

2. The Price to Sales Ratio ignores capital structure

One of the peculiarities of the Price to Sales Ratio is that it truly favors companies with high levels of debt. Because it compares 1 number (market capitalization) that is dependent on a company's capital structure to a different number (sales) that is not, it essentially ignores whether a company is funded with equity or debt. This is not a trivial distinction. For example. presume beneath that we have 3 companies with exactly the identical businesses. They every have identical future prospects and operating income, and the only difference is the capital structure and the amount of debt used to finance every.

Earning:   Approval pending.