EV to sales multiples When we're using EV multiples, we have a range of earnings metrics that we can use in our multiples such as ebit or even ebitdar. But what if a company has negative or volatile earnings? Here's an example of a company gamma inc and we have revenue and earnings on a historic basis along with forecasts for the next three years. gamma inc appears to have quite variable revenues or possibly cyclical revenues because of the effect of fixed costs in a company's cost space this results in a reasonably volatile ebitda measure and a very volatile ebit measure with negative ebit expected for fy1. Gamma incs EV is 9 billion dollars and we can use this to calculate the company's EV to ebit and EV to ebitda multiples. What do we notice when we do this? We'll firstly we should note that there is no EV to ebit multiple for FY 1 and negative multiple is not meaningful so we can't include it in our analysis. Whilst we could place Reliance on historic fy2 or fy3 multiples or even Place Reliance solely on EV to ebitdom multiples. We can see that all of these multiples are extremely volatile following the same trend that we observed in the earnings forecasts. This makes it really tricky to try to understand what is being reflected in the multiples. An alternative instead is to use EV to sales multiples in our analysis. When we do this. We immediately see that EV to sales is much more stable than the other multiples. Also because sales is positive by definition and easy to sales multiple will always be available no matter what changes the business is undergoing or where we are in the economic cycle. Although EVs of sales can be an extremely stable and useful multiple. We do need to remember that all multiples rely on the value driver being a good predictor of cash flows to investors. In the case of Eevee to sales. We're assuming that sales are a good predictor of cash flows for investors. This is a rather crude assumption as there are lots of reasons why growth in a company's revenues might not translate into growth in investor cash flows. We can therefore say that there is a trade-off with earnings multiples multiples that rely on inputs from further up the income statement such as EV to sales are very stable, but these inputs have a weaker link to investor cash flows. Conversely multiples that rely on inputs from further down the income statements such as EV to ebit or more volatile, but these inputs have a stronger link to investor cash flows.