When it comes to predicting stock prices, we all want convenient, easy-to-use metrics that will give us the answer to our question: Can I make money in this stock? Unfortunately, like many things in life, simple and quick short-cuts can lead us to the wrong conclusions. It's been a little over a year since I attempted to debunk one such valuation tool, the PEG Ratio, which I called "silly" (perhaps a bit too sensational!). That article, as old as it is, still gets hundreds of views a week, suggesting to me that these discussions of how to value stocks are of interest.
Today, I want to tackle another popular metric, known as "Price/Sales" (P/S). To calculate the value, and here is the simple part, all you need to do is divide the market cap (price of stock times number of shares outstanding) by the trailing sales (typically the last four quarters). The result is always a positive number. You can apply this to an individual stock or even to the whole market. The S&P 500, for instance, currently trades at 1.4X its trailing sales. This is pretty much the middle of the road for the past two decades, with a range of 0.7 (early 2009) to 2.3 (2000).
While there are many circumstances that are appropriate for using sales, like when there are no earnings, it can't be used without understanding how to use it properly. The bottom line is that you can't make money buying low P/S stocks (or shorting high P/S stocks) blindly.
What's Wrong with P/S?
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