This Stock Market Valuation Measure Has Important Implications For Investors
The Price/Sales Ratio Says Much About Where We Are and Where We’re Likely Going
The record high P/S ratio (over 3X) creates a poor risk/reward proposition not only because it has produced the currently sky-high valuation measures but also for its implications years ahead.
Since earnings are a function of sales, the high P/S ratio will make it very difficult for companies to maintain current earnings growth at their current prices. The effect of a sales increase of 15% when one is paying 1X sales is much greater than if one is paying 3X.
As well, it is unrealistic to believe that profit margins can expand sufficiently to justify current earnings growth expectations based on the current P/S ratio.
Therefore, as occurred after the internet bubble, the market may require an extended period of weakness to return to a P/S level that will allow for a return to conditions favouring strong earnings growth rates.
The current environment requires a strategy to preserve profits and mitigate risks in the event of a correction, and seize opportunities following a market decline. We share our strategy on global markets in each monthly issue.
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