By John Del Vecchio and Brad Lamensdorf
The number of stocks in the S&P 500 trading over 10x sales has skyrocketed to 73. Meanwhile, the median price to sales ratio for the index has hit a nosebleed 3.5x. When this bull market started in 2009, the ratio was less than one and you would have had to look hard for a stock trading above 10x sales.
Historically, price / sales has been a powerful valuation measure. Sales can be manipulated. John wrote an entire chapter in his book What’s Behind the Numbers? on a number of ways management teams can artificially boost the top-line.
However, the games played are more desperate at the top of the income statement. Meanwhile, between revenue and earnings there are many levers management can pull to generate earnings and “hit the number” to please investors. As a result, price to sales is often a preferable measure of valuation than earnings.
Ken Fisher introduced the measure in Super Stocks. Back in the 1980’s, it was crazy to see technology companies trading above 3x sales. We’ve come a long way! Fisher pointed out that when companies trade at those premium levels, all it takes is a glitch to send the stock plummeting.
It could be a revenue shortfall. Or increased competition. Possibly pricing pressure. It does not matter what. Expectations were so high that only perfect execution would do.
Now the entire index is trading over that level. 15% of the index is trading over 10X sales.
Should a glitch occur, and it could be anything, the downside is tremendous from here.
It’s likely to be epic.
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Originally Posted on November 21, 2021 – The Glitch
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