Intro to Finance: Valuation Using Multiples, PE Ratio vs Price to Sales

You can value a stock without discounting a single dividend, by pricing it the way the market prices its competitors. A PE ratio of 18 means investors pay $18 for every dollar of earnings per share, and a price-to-sales ratio of 1.5 means they pay $1.50 for every dollar of sales per share. Flip each ratio around and the price is the industry's multiple times the company's own per share number. Two apparel companies are valued against an industry that trades at 18 times earnings and 1.5 times sales: Halcyon Apparel earned $3.20 per share on sales of $40.00 per share, and Tidewater Apparel lost $0.80 per share on sales of $25.00 per share. Halcyon is worth $57.60 by PE and $60.00 by price to sales, and both estimates are usable. Tidewater's PE estimate is a negative number, which is worthless because a PE ratio only means something when earnings are positive, so you go up the income statement to something more robust: price to sales gives $1.50 x $25.00 = $37.50, the estimate to trust. The video closes by reading these numbers as a benchmark, a hint about whether a stock looks over or undervalued next to its competitors, not the ground truth. The problem: Two apparel companies are being valued against their industry. Halcyon Apparel earned $3.20 per share last year on sales of $40.00 per share. Tidewater Apparel lost $0.80 per share on sales of $25.00 per share. The other apparel companies trade at an average of 18 times earnings and 1.5 times sales. Value each company's stock using the PE ratio and using the price-to-sales ratio, and say which of those estimates you can trust for each company. Part of the Intro to Finance series with Dr. Harrison Ham. (c) Harrison Ham, Department of Finance, Clemson University