The Tornado Report (see list below) is published by Patrick Lannigan at the end/beginning of each month. It is centered around the Enterprise Value/Sales Ratio (EV/S). 

EV/S gives us the quickest possible indication of the perceived value of a high tech company versus its sales. No other ratio does this. It works so well because it accounts for market capitalization, cash on hand, debt, and trailing 12 month sales, in a single figure. One look at the number and you have a pulse on a company's perceived health.

EV/S  formula is:

FYI - those that have been reading these reports for a number of years will remember that, in the beginning, the EV/S was referred to as the Tornado Ratio. It's still the same "ratio" per se, except over the years the term "Enterprise Value" became more popular and thus (seeing as it referred to the same equation), was adopted!

The Tornado Report(s)

Here are the Tornado Reports!

TR::May 3, 2005 (tr050305.xls)

TR::April 4, 2005 (tr040405.xls)

TR::March 3, 2005 (tr030305.xls)

TR::January 31, 2005 (tr013105.xls)

TR::December 31, 2004 (tr010205.xls)

TR::December 3, 2004 (tr120304.xls)

TR::October 29, 2004 (tr103104.xls)

TR::October 5, 2004 (tr100504.xls)

TR::September 2, 2004 (tr090204.xls)

TR::August 19, 2004  (Google IPO Day)

TR::August 3, 2004 (tr080304.xls)

TR::June 30, 2004 (tr063004.xls)

TR::June 5, 2004 (tr060504.xls)

TR::Oct 31, 2003 (tr10310303.xls)

  TR::Mar 24, 2003 (tr032403.xls)

TR::Feb 28, 2003 (tr022803.xls)

TR::Jan 31, 2003 (tr013103.xls)

TR::Dec 31, 2002 (tr123102.xls)

TR::Nov 27, 2002  (tr112702.xls)

TR:: Oct 31, 2002 (tr103102.xls)

TR::Sep 30, 2002  (tr093002.xls)

TR::Aug 30, 2002  (tr083002.xls)

TR:: Jul 31, 2002   (tr073102.xls)

TR::Jul 19, 2002    (tr071902.xls)

TR:: Jun 28, 2002 (tr062802.xls)

TR:: May 31, 2002 (tr053102.xls)

  TR::Apr 30, 2002 (tr043002.xls)

  TR::Feb 9, 2002 (tr020902.xls)

  TR::Dec 21, 2001 (tr2001.xls)

  TR::Oct 27, 2001 (tr102701.xls)

What is a Tornado Report?

The Tornado Report, published at the end of each month, is centered around the Enterprise Value/Sales Ratio (EV/S). 

EV gives us the quickest possible indication of the perceived value of a high tech company versus its sales. No other ratio does this. It works so well because it accounts for market capitalization, cash on hand, debt, and trailing 12 month sales, in a single figure. One look at the number and you have a pulse on a company's perceived health.

The Tornado Ratio (EV/S) formula is:

To understand the EV/S let's look at a real example from 2002.

On July 31, 2002, Inktomi (Nasdaq: INKT) had a EV/S of-0.16.

What does this tell us? It tells us two things immediately.

1. Their market capitalization is less than their cash. (this happens when the EV/S turns negative).
2. Their sales are greater than their market capitalization minus their cash by 16%. (the -0.16 indicates that if you bought them you'd get them for "free" plus a bonus of 16% of their annual sales).

So why doesn't somebody just rush in there and buy them? Well, for one, management usually thinks they're going to turn it around. Look at Liquid Audio. On July 31, 2002 they had $3 million in trailing 12 month revenue, $86 million cash, and a market cap of $57 million. Investors want Liquid Audio to shut down and distribute the cash. Management says they think they can turn the company around. There are many other reasons these "free" companies aren't scooped up, but we'll discuss that some other time.

In Inktomi's case, Yahoo ended up buying them in a deal worth $235 Million. 

What about a high EV/S?

A EV/S of 1.0 indicates that investors believe a company's  value to be, after cash is subtracted from market cap, to be 1 times revenue. The higher the EV/S the better investors think that the prospects are. As an example, during the dot.com madness, (January 2000), Yahoo had a EV/S of 228.9! Their market cap was over a $100 Billion dollars and revenues were$475 million with $676 million in cash. If we fast forward to July 31, 2002, we see that Yahoo's EV/S has contacted to 9.15. Still high, but not if the company is going to grow rapidly. Will it? Is that EV/S too high? What are their prospects? Is there an opportunity to short the stock, or will Microsoft buy them and wipe out any short position?

Disagree with the EV/S? That's a Good Thing!

Opportunity comes, in regards to the EV/S, when you disagree with the way investors feel. From an acquisition perspective, this is especially valuable. Perhaps the company you are eyeing is spending all their dollars on creating new new stuff when, in fact, you believe that if they focused on their old stable revenue they would be profitable. You, of course, could acquire them, give them new religion, and then dramatically reduce their expenses so the acquisition was accretive to your bottom line. Its never that easy, of course, but it has been done. Another way to profit is through buying or shorting the stock depending on whether you believe the EV/S is too low or too high.

 Background to the Name "Tornado Report"

In the beginning, there was just "the ratio". I, nor Joe Alsop, who was the primary reason this report was developed, weren't familiar with the "Enterprise Value" calculation. Still, the figure we came up with was, in fact, Enterprise Value  - a figure that was coined by economists. We needed to come up with a name for our "Ratio" so, in honor of Geoffrey Moore (author of Inside the Tornado) we named it the "Tornado Ratio". Geoff Moore gave his thumbs up to the name and the ratio was thus christened. In subsequent years, the term "Tornado Ratio" was eliminated and it was decided that the term "Enterprise Value/Sales" should be used (as the term "Enterprise Value" is growing in popularity). 

The name of the report, however, remains "The Tornado Report" because, in my opinion, it is a far better name than the "EV/S Report"!

Ways to Use the Tornado Report

The Tornado Report is used in a number of ways, including:

Peer Performance Comparison A quick way to evaluate how investors feel about a peer company's value compared to other companies in the same peer group or market segment.

Discover an Undervalued Company. A quick way to highlight a company that you believe is worth more than the current perceived value (perhaps there is a strategic or investment opportunity for you or your company).

Discover an Overvalued Company.  A quick way to highlight a company that you believe is worth less than the current perceived value (you could decide to avoid investment, short the stock, avoid a corporate relationship, etc.).

Needless to say, you should never make any investment or strategic decision based on the Tornado Report by itself. Do your analysis. Work with professionals. 

_______________________________

The EV/S, Generally Speaking

Generally, the higher the EV/S the greater investors' expectations are for the company's future success (which, of course, may not be founded on reality). Nevertheless, it is the "perceived value" that the EV/S reflects. You must watch, of course, for thinly traded stocks, or stocks with very thin floats. Also, there are a number of stocks at this time (mid 2002)that are simply being buoyed by stock buy-backs from the company's cash reserves. Stock buy-backs are a good thing but you should at least be aware of who is doing a lot of the buying. Companies that buy back their stock are required to document these facts in their 10K reports filed on sec.gov. 

EV/S Range Generalizations.

The EV/S  is just a quick way to understand how investors feel about a company. If the EV/S goes up by a 10th or down by a 10th of a point, there is no definitive point that suddenly turns a healthy company into a sick company or vice versa. Generally, however, the following "ranges" can be used as guides. 

Broad Sweeping Generalizations:

(These ranges also differ depending on whether a particular high tech company is more service or product oriented. As an example, a EV/S for a rapidly growing and profitable consulting firm will usually never be as high as the EV/S  for a rapidly growing and profitable software product company)

EV/S between 0.8 to 1.1
Generally a EV/S between 0.8 and 1.1 means that the investors' expectations are not that great for growth, but they haven't written the company off yet. 

EV/S below 0.8
As the EV/S falls below 0.8 and moves lower, this generally indicates that investor sentiment towards the company also moves lower in proportion to the EV/S value until, finally, in the case of a EV/S of zerp, the outlook for a company is perceived to be so bad that it is only valued for the company's cash. In some cases, (a negative EV/S), a company is actually valued at may be losing so much money every month, a company could be valued at an amount that is less than the cash they have at hand.

EV/S above 1.2
As the EV/S rises it can be said that investors' hopes for the company also rise in proportion. Of course, these hopes can be dashed, as was the case with many of the dot.com's.

Thanks,
Joe and Geoff

Joe Alsop was the reason this report was developed in the first place. Joe Alsop is the CEO of Progress Software (Nasdaq: PRGS). To say I learned a lot from Joe, during my three terms at Progress Software, is an understatement. I cannot say enough about how he challenged and inspired me while I was there.

Geoffrey Moore gave his blessing for me to call this report the "Tornado Report". This kind of name makes it easy to remember and gets to the point of why I'm in this business (seeking the next "tornado" and building long term shareholder value). Geoffrey Moore, of course, gave high technology a new lingua franca with his books: Crossing the Chasm, Inside the Tornado, The Gorilla Game, and Living on the Fault Line. To an outsider it must seem very strange to hear the words "tornado" or "bowling pin" or" chasm" when referring to a high tech market. Thanks Geoff.