The regression yields results similar to those obtained for
price-to-bookratios,andtheR-squarediscomparableat57.3
percent. The return on capital remains the key variable
explaining differences in the EV/capital ratios across firms.
If the results from using value-to-book and price-to-book
ratiosparallel eachother, whychoose to use one multiple
over the other?The casefor using value-to-book ratios is
stronger for firms that havehigh and/or shifting leverage.
Firmscanuseleveragetoincreasetheirreturnsonequity,but
in the process they also increase the volatility in the
measure—in good times they report very high returns on
equity, and in bad times, very low or negativereturns on
equity. For such firms, the value-to-book ratio and the
accompanying returnoncapital willyieldmore stableand
reliable estimates of relative value. In addition, the
value-to-bookratiocanbecomputedevenforfirmsthathave
negativebookvaluesofequityandisthuslesslikelytobe
biased.
EV/Sales Ratios
Inthefinalregression,thecross-sectionaldataforfirmsinthe
United States in January 2006 is used to estimate the
enterprise value-to-sales ratio, with the after-tax operating
margin, theexpected growth ratein revenues (g), and the
reinvestment rate (RIR) used as independent variables:
Theoperating margin used wasthemargin from themost
recent financialyear,theexpectedgrowth ratein revenues