Like all valuation models, EV/Sales involves a lot of subjectivity. The factors behind a normal margin are complex – the simple process above is designed to help improve the probabilistic assessment of outcomes. Similarly, whilst sales are often more persistent than earnings, sales might by so unstable as to make EV/Sales no better than earnings multiples. In addition, use of the tool requires understanding the various pitfalls in calculating EV and the potential volatility involved in applying the multiple with leveraged companies.
Nevertheless, EV/Sales is a useful tool that can often provide additional information. It may help reinforce a value story, or it may contradict it. In both cases this is useful. As a bare minimum it can dial up or down our confidence in an investment thesis.
Classically cyclical companies, where margins exhibit lots of volatility around some normalised level, are a good example of where the tool can be most useful.