Suppose you live in a two dimensional world. The only dimensions are price and sales. When comparing investments you must rely on P/S, the only dimensions known to you. A P/S of one is twice as good as a P/S of two.
(P/S-A = 2) < (P/S-B = 1)
By the magic of SciFi you are traspondered into a three dimensional world. The additional dimension is Net Margin. If company A has a P/S of two and a Net Margin of 10% while company B has a P/S of one and a Net Margin of 5%, then P/S-A of 2 is the same as P/S-B of 1. On sales of $100 company A makes 10%, $10 while company B on sales of $100 at a Net Margin of 5% makes $5. You pay twice as much for $10 that for $5.
(P/S-A = 2) = (P/S-B = 1)
Now add another dimension, revenue growth. Suppose company A is growing revenue twice as fast as company B…
(P/S-A = 2) > (P/S-B = 1)
Investors need to realize that we live in a complex multidimensional world. Magic numbers don’t exist. We live in a world where the past does not matter, all that matters is the future which is unknown! This is the reason I find the business model and the “S” curve concept so useful to create a mental image of what the future might look like. For a company growing revenue at 100%, a current P/S of 50 becomes 25 next year if the stock price does not change.
Denny Schlesinger
I hope I got my numbers right 