P/S and Future Expected Returns

Many of your stocks followed here have very impressive P/S ratios…are you holding potential timebombs?

I have been looking over several stocks recently from the perspective of how they might perform if the numerous companies that are guiding lower revenue for 2019 actually materializes…that is, if this were to be a larger swath tech industry trend (potentially over-built tech sectors, etc.) how might the higher P/S stocks behave from a return probability perspective.

Many of these “nosebleed” stocks can have rather violent stock movements with any suggestion of lowered guidance because so much growth is already priced in. I am going to set up a couple hypothetical portfolios of NPI type stocks (NPI, Bert, Gary, Saul, etc.) with the only criteria separating them being a high P/S (perhaps those above 10 and below 10 although I may choose below 10, 10-15 and above 15).

The theory goes that the higher P/S stocks will underperform lower P/S stocks. What is this based on?

There are numerous studies that suggest the highest P/S stocks will perform the worst in future years. Here is one example:


You can see that stocks in the highest quintile of P/S are usually the worst investment performers.

One of the very few stocks that I have seen maintain a very high P/S is FB (now at 12 with recent drop)…not even GOOG or AAPL has had such nosebleed levels. Some here have argued that SHOP is the equivalent of the FB anomaly but IMO, this contorted logic is what gets people in trouble…arguing by exception.

Tinker has argued to stay invested in stocks with growing revenue irrespective of them being high valuations and that lower valuations stocks are low for a reason…there is some sound logic in that assertion. I have argued that there is often a huge disconnect between a technology adoption lifecycle and the accumulation of the stock…something I have coined the TALC/SALC disconnect…and that stocks can sometimes get way ahead of themselves. These two viewpoints are NOT mutually exclusive.

There are numerous examples in recent past of similar extreme high P/S stocks like LNKD and TWTR that dropped precipitously. If you contemplate similar asset class historical records, one needn’t go much further than to the 2000 bubble when tech stocks like MSFT traded at P/S of 35 and CSCO traded at 37! We are not there yet.

The FOOL also had an article here with some historical context as well:


When investors pay an irrational P/S ratio, they pay for irrational growth. When investors buy stocks with high P/S ratios, those stocks need to grow revenue at least 30%-40% on a yearly basis for many years into the future. This is because investors are paying a big premium today for growth that is expected to happen in the future. But, with any deviation from future growth expectations, the premium paid today may no longer be deserved. As a result, and because an irrationally high P/S ratio cannot be maintained by an increase in revenue growth, the stock is likely to collapse.

I made a similar argument with SHOP back in Oct 2017 when the P/S was well above 20 and the stock traded at 116…now up around 6% since then…though I know many of you bought it again at even lower values when Citron did their “magic”.

But let’s look at a few of your/our favorites:

AYX P/S 17
ZS P/S 21

MDB P/S 12
ZEN P/S 12
ZUO P/S 12

SQ P/S 6

I fully recognize there are various “qualifications” like drugs stocks, growth rates and forward P/S’s, etc. But those arguments for another day.

I am just doing a fun compare and contrast between tech driven stocks that might show up in NPI type investing to track an equal weighted portfolio based on valuations. I will report results from time to time.

Anyone care to add other tech stocks you think have the greatest promise of all?



Hey Duma,

If we could see a new study done and include a requirement for 40% minimum sales GROWTH, I
might be interested. As it stands in the article, this is like grading the Dow returns by
P/S on a particular date, and makes perfect sense.

If you perform the same calcs on the Dow, I would guess they would be similar to the
author’s results. I mean no offense at all when I say this, but I don’t give a damn what
the Dow does.

I would love to see what the growth requirement would do. Or, we can wait 2 years and see
how the current crop of high flyers does by Dec 31, 2020. (Personally, I’m not worried
about them falling in the fifth quintile. Or Forth. Or Third.)

Are you?



if it matters, I don’t want to be a defender of these types of stocks and I’m hardly well-informed, but perhaps you can’t look at price to sale ratios without looking at return on investment. SHOP for example, grew revenue by 284m last year but only spend an additional 20m in capital expenditures. The business model by design, along with most of the stocks on this board, are by definition ‘asset-lite’, meaning that they can grow revenue - often by very large percentages - with very little incremental capital. This means that if they can ultimately translate those sales into profits then profits can be grown with very little incremental capital, which is the most desirable trait in a business. Implicit in this is the assumption that eventually these companies will begin to generate bigger and bigger operating cash flow flow (which, by the way, is not artificially pumped up by too much share based compensation, which has its own cost resulting in a higher share count). This sets them up for high expectations and high multiples.

you can see this in a mini-way in a retail I follow - OLLI, which spends VERY little on new store growth (by definition they don’t look for fancy real estate and the fixtures look like hand-me-downs) vs. a similar company like Big Lots which has embarked in a massively expensive capital expenditure program to upgrade their stores. Maybe Big Lots needed to do this, but one dollar earned at OLLI is far more valuable than one dollar earned at BIG. It is like the old Chuck-e-Cheese, where you’d cringe that they had to do another round of game upgrades - necessary, but costly.

Of course, if sales growth slows in these companies, that’s a suggestion that either market share is being taken by others or that the total addressable market might not be as big as it seems, but you can see the pinnacle of these folks when you look at somebody like Amazon which is seen as having an addressable market as big as planet Earth (which, by the way, makes lonely observers like me who think the Whole Foods buy was stupid but ultimately irrelevant because it brought then into the more pedestrian world of fixed store counts and required Capital investments to keep up but in the end will probably treated as an isolated incident).

Bottom line - you grow sales without capital investment, you deserve a high valuation, assuming one day profits flow, but if you grow profits to expand sales, then investors will accept a LOT of things if they think the market is big and expanding. Of course, downside action will be tough in any recession or downturn, but that’s accepted by everybody on this board.

Just 2c - not sure it means anything

P.S. I thin LKND was bot at 8x sales, right?

you don’t have to accept this, but here is an analyst justification for high vauations

Stifel Nicolaus’s Tom Roderick, reiterating a Buy rating on Salesforce stock, and a $142 price target, seems exuberant about the prospect for lots more pricey cloud software M&A, as he explains the logic of over-paying for an asset:

That noise you just heard was the proverbial valuation ceiling for public SaaS companies shattering into a million pieces. We wrote it above, and we’ll note it again. Salesforce.com just paid 12x 2019 revenues for Mulesoft. Do not confuse our belief that Salesforce overpaid for Mulesoft with our more fundamental opinion that the asset makes perfect sense for Salesforce. We think it’s okay to hold both opinions. Without knowing exactly how this situation played out just yet, the nature of today’s mid-day leak (leading to share of MULE finishing the day up 27% at $42.00) leads us to believe there was a multi-party bidding war that Salesforce figured it had to win. So, in that manner, the situation is highly reminiscent of the Demandware deal, which the proxy filing will eventually make more clear in a few weeks.


The business model by design, along with most of the stocks on this board, are by definition ‘asset-lite’, meaning that they can grow revenue - often by very large percentages - with very little incremental capital.

Exactly right. For a fair comparison compare the Wintel Twins.

A poster recently said that he does not like retail because it has razor thin margins. I had the opportunity to advise a supermarket chain and I asked them how they could convert such thin margins into 30% return on capital. The chief buyer (the most important job in the business) told me that they had to sell the merchandise three times before paying for it. In other words, if they got 30 day terms from the supplier the stuff had to be off the shelves in ten days. They were working with OP money! I also worked at Colgate-Palmolive where I saw that large customers, i.e. supermarket chains, had a huge amount of leverage on the CP. CP had to meet quotas and was willing to stuff the supply chain go get there. Big buyers could game CP, “we’ll take the merchandise under OUR conditions.”

For proof, check out Walmart. LOL

Denny Schlesinger