Revenue to Stock Price Ratio
The term revenue to stock price ratio refers to a calculation that allows the investor-analyst to understand a company's ability to convert sales to profits. The revenues to stock price ratio is typically calculated after new sales revenues values are announced.
Revenues to Stock Price Ratio = Annualized Revenues / Price of Common Stock
- Annualized revenues are equal to the historical view of revenues, typically over the last quarter or year. When using timeframes shorter than one year, the investor-analyst needs to account for any seasonality in sales. This first value will be used to calculate the baseline ratio.
- A second annualized revenues value will also be the used for the comparative metric. This value will typically be that articulated by senior management in a recent announcement.
- The price of common stock for the baseline period will be the average price over the timeframe examined for historical annualized revenues.
- A second value for price of stock will be used for the comparative metric. This will be the price of common stock following the announcement of an increase in annualized revenues.
Market performance measures allow the investor-analyst to understand the company's ability to achieve their high level business profitability objectives. This is usually assessed by examining metrics such as insider transactions, capture ratios, enterprise value, capitalization rates and price to earnings ratios. Market performance metrics provide analysts with a way to determine if a company is going to successfully execute their business plan. One of the ways to determine how confident investors are in a company's ability to turn sales into profit is by examining the company's revenues to stock price ratio.
When an investor-analyst evaluates the purchase of common stock to hold in their portfolio, one of the metrics to consider is the revenues to stock price ratio. This metric is calculated by taking an annualized revenue value and dividing it by the common stock's price over the same timeframe. The resulting ratio will be the baseline performance metric. A second calculation is performed immediately following the disclosure of a change in revenues. Typically, this change is announced by senior managers during an investor conference.
When a company announces an increase to revenues, the price of common stock should immediately react positively to such an announcement unless the market is not confident in the company's ability to convert the additional sales into profits. Comparing the baseline performance metric to the post-announcement ratio will help the investor-analyst understand the market's confidence in the company.
During Company ABC's April investor conference, the CEO discussed not only first quarter results, but also announced a 30% increase to revenues due to the closure of a ten-year government contract. No other material announcements were made during the meeting.
A mutual fund manager had been holding Company ABC in his portfolio and he was wondering how confident the market was in Company ABC's ability to turn this 30% increase in revenues into profits. He asked his team to calculate the average stock price for Company ABC in the preceding year as well as its revenues. He then asked his team to compare the recent increase in price for Company ABC to the newly announced revenues. His team's findings appear in the table below:
The fund manager was disappointed to learn the revenues to price ratio increased significantly, which means the market is not confident Company ABC will be able to convert the 30% increase in revenues into profits as efficiently as it has done in the past.