How do you value the Afterpay (ASX:APT) share price?

How exactly does one value Afterpay shares?

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How exactly does one value the Afterpay Ltd (ASX: APT) share price? That’s a question that has vexed ASX investors for years now. This ‘guessing’ has resulted in Afterpay’s share price (or valuation) being infamously volatile.

It’s easy to forget at today’s pricing, but in March last year, Afterpay shares got down to a price of roughly $8 a share. Less than a year later, the company hit a share price of $160.05, giving investors a gain of more than 1,100% in the process.

As is evident, exploiting how other investors (aka ‘the market’) value a company at a particular point can be highly lucrative if you have a better understanding of what something is worth. Of course, it’s that ‘understanding’ that is the hard part, or we’d all be billionaires.

Put oversimply, investors may have assumed at the onset of the coronavirus pandemic last year that Afterpay was worth very little, seeing as the country was about to face a recession.

But when it became apparent that the coronavirus wouldn’t be bringing widespread economic destruction with it (the awful economic costs of lockdown notwithstanding), investors decided to quickly revalue the Afterpay share price.

As the legendary investor, Benjamin Graham once said, ‘The share market is a voting machine in the short run, and a weighing machine in the long run’.

P/E ratio? Computer says no

So how does one ‘weigh’ the value of Afterpay? we’ve already established that this is a difficult task. But why? Well, the most common way investors tend to value a share is by using the price-to-earnings (P/E) ratio. By comparing each dollar a company makes to its share price, we can easily compare different companies just based on their respective profitabilities.

This P/E method works very well with companies with established cash flows and mature businesses. For example, we can look at Commonwealth Bank of Australia‘s (ASX: CBA) current P/E ratio of 21.3 and say that investors are valuing each CBA share at a higher rate than those of its rival Australia and New Zealand Banking Group Ltd (ASX: ANZ). ANZ only has a P/E ratio of 16.9.

However, that doesn’t work so well with Afterpay. Why? Well, because Afterpay doesn’t officially make any money yet. Sure, it brings in a seemingly ever-expanding pile of revenue. But in its earnings report for FY21 which Afterpay released last week, the company reported a statutory loss of $159.4 million. It’s hard to rate Afterpay’s earnings against its share price when it doesn’t officially have any to speak of just yet.

That’s why you won’t see a P/E ratio for Afterpay floating around.

So the P/E is out, what else can we use to value this buy now, pay later (BNPL) pioneer Afterpay?

How exactly do investors value the Afterpay share price?

Well, there is another metric that some investors like to use for companies facing this predicament. That would be the price-to-sales (P/S) ratio. The P/S ratio works similarly to the P/E ratio, but uses ‘sales’, or revenues, instead of earnings.

So Afterpay does have a P/S ratio, it’s currently 46.8. Using this metric, we can see that Afterpay, for example, is being priced with a far higher P/S ratio than its BNPL rival Zip Co Ltd (ASX: Z1P). Zip presently has a P/S ratio of 9.53.

Just for comparison, Woolworths Group Ltd (ASX: WOW) currently has a P/S ratio of 0.95.

The P/S ratio is no silver bullet when it comes to valuing companies like Afterpay. But it can give a very useful indication of exactly what you’re paying for when you buy Aferpay shares today.

But now Square Inc (NYSE: SQ) has decided to buy out all Afterpay shares for the price of 0.375 shares of Square per Afterpay share, there might be an even easier way to value this company.

At yesterday’s closing Afterpay share price of $134.59, the company has a market capitalisation of $38.32 billion.

Should you invest $1,000 in Afterpay right now?

Before you consider Afterpay, you'll want to hear this.

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Motley Fool contributor Sebastian Bowen owns shares of Square. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended AFTERPAY T FPO, Square, and ZIPCOLTD FPO. The Motley Fool Australia owns shares of and has recommended AFTERPAY T FPO. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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