Do high EV/S ratios hurt returns? - a study
Duma did an interesting little trial test on the NPI board a year ago. He divided up the stocks that they (and we) were talking about most into three groups by EV/S.
The three groups (each with roughly 10 stocks) were:
EV less than 10
EV between 10 and 14
EV over 14
The idea was to take a look a year later and see if high EV/S (“overvalued” stocks) really led to less return after a year.
His results were very interesting:
The low EV/S had by far the worst results with an average gain of 37%
The medium EV/S group had the highest results with an average gain of 77%
The high EV/S group was right behind with a return of 68%. However this one had a negative-ringer in it, that didn’t really belong. It was the only one that included a biopharma, NKTR, which it was a huge outlier from the beginning, being a biopharma in the first place, and having a EV/S of 47 (next highest out of ALL the stocks was EV of 21). It lost 67% of its value in the course of the year, and the high EV group STILL managed to gain 68%. Without NKTR, with a more homogeneous tech group like the other two groups, it was up 82%, with the best score.
So much for high EV/S killing results.
And it further turned out that the overall BEST determinant of future results was starting revenue growth rate… Well, what do you know? What a surprise…duh.
The stocks starting out with the highest revenue growth rates were the nine companies with revenue growth rates of 55% to 75%. Their average return for the year was 138% !!! There were only two outliers that didn’t do well, Elastic and Shopify who grew at only 24% and 35%, and the group grew at 138% anyway!!! These two (Elastic and Shopify, happen to be the two that I exited (well, exited Shopify and just-about exited Elastic). I still own all the others : Alteryx, Twilio, Smartsheets, Zscaler, Okta, Mongo, and The Trade Desk.
Remember that Duma, made this experiment a year ago, on the NPI board, and I didn’t know anything about it until now. The results however seemed pretty clear, highest revenue growth rate stocks and stocks with EV/S over 10 had VERY substantially better returns than slow growing and low EV/S stocks.
Here’s a link if anyone is interested in following further. https://discussion.fool.com/tinker-modern-portfolio-theory-34169…
And a big thanks to Duma.