I enjoy Nick Maggiulli’s Tuesday Blog Post. I find them thought provoking. The presentation for 23 November is no exception.
As compared to most others he has produced though, I don’t quite agree with the meaning derived.
The point of the article The article is headlined This will not last. The article addresses stock price to sales ratios. Historically very high ratios have presented before disaster. There is a fascinating graph showing 2000 and now for stocks with price to sales greater than 20x. It looks pretty scary.
But, there are not so many of these Their total market value is less than 10% of the market. They are the speculative part and if you address them accordingly, you may be okay.
Sales don’t matter much on an aggregated and averaged basis.
Why not? Sales don’t translate very well to profitability and profitability drives the share price. A better ratio to notice is gross margin to price. Gross margin is what you make after the price of what you sell and before overhead costs.That separates companies like Walmart, ( 25%) Apple (42%), and Amazon (40%) from others like Microsoft, (69%) Facebook (80%) and Google (58%). Of these only Amazon and Google have changed much. Their margin historically is Amazon 20%-35% and Google 58% to 60%.
To make a dollar before overhead you would divide $1.00 by the Gross Margin percentage. So Facebook needs $1.25 of sales before overhead to generate $1.00 of margin, and Walmart needs $4.00 The others are somewhere between. Clearly the price to sales ratio makes little sense aggregated and averaged.
It does help us understand a particular company when mixed with some other factors.
Gross margin does not necessarily become profit. Companies have varied overhead structures and an investor is looking for net income. The rest are just numbers. The numbers change in time too and that has meaning.
Here’s a chart to think about.
|Price to sales ratio||4||8||9||10||15||0.7|
|Gross margin % of sales||40.0%||42.0%||80.0%||53.0%||69.0%||25.0%|
|Net income % of Sales||5.5%||25.9%||33.7%||22.0%||36.3%||2.4%|
|Direct Cost of Sales||60.00||58.00||20.00||47.00||31.00||75.00|
|Overhead, taxes, etc||34.50||16.10||46.30||31.00||32.70||22.60|
|Net income per $100 of sales||5.50||25.90||33.70||22.00||36.30||2.40|
|Price to earnings Ratio||69.0||28.5||24.0||24.0||37.5||49.5|
|G M. % compared to history||Rising||same||same||falling||high end of range||same|
|Sales||Rising at 30%||Sharp Increase||Warning of slowdown||Rising more slowly than history||Rising at a faster rate than history||fell in 2021|
There are many factors that matter in addition to price to sales ratio. It is the correlation of the ones shown plus many more – competitors actions, management stability, potential lawsuits, Supply shortages, customer sentiment,
Most of these companies have many sections. The totals of sales and profits is not as meaningful as many think.
That price is not always sustainable. The article talks about companies with a value to sales higher than 20x. Again, it would be important to put those into context before deciding what might be reasonable. Some of them may well thrive, but it is a worrisome position.
No single variable describes a business. Look for many indicators and how they fit. For example, a business with significant debt behaves differently than those without.
Price to sales is a place to begin because young companies have no net income, so many common variables are meaningless.
Forward looking executives matter more than numbers.
Finding customers beyond the early adaptor crowd is where the real money lives.
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