Previously i talked about what are bubble stocks.
We use either PE Ratio OR PEG Ratio to value whether a stock is a bubble or not
The important thing to note is that the above ratios are only applicable for companies which have earnings.
There are also companies which are growth stocks and yet do not have earnings – meaning they are operating at a loss.
For such companies , we use another ratio to value them. We call this ratio the PS Ratio – Price to Sales Ratio.
The price-to-sales ratio (Price/Sales or P/S) is calculated by taking a company’s market capitalization (the number of outstanding shares multiplied by the share price) and divide it by the company’s total sales or revenue over the past 12 months. The lower the P/S ratio, the more attractive the investment.
PS Ratio = Market Cap / Total Revenue OR Sales
The market generally accepts that a PS Ratio of 1 is the generic benchmark of a fairly priced growth stock which do not have earnings.
There are also companies which are in the mature phase of their business cycle and are having negative earnings. Do we apply PS Ratio to these companies ? The answer is obviously No !
Comparing Stocks in Oil and Gas Industry
PS Ratio alone is not enough
The P/S ratio doesn’t take into account whether the company makes any earnings or whether it will ever make earnings. Comparing companies in different industries can prove difficult as well. For example, companies that make video games will have different capabilities when it comes to turning sales into profits when compared to, say, grocery retailers. In addition, P/S ratios do not account for debt loads or the status of a company’s balance sheet.
There are also disruptive companies which do not have peers.
A very good example is Palantir $PLTR. For such stocks, their revenue and operating income will need to justify the PS Ratio eventually if it is too high ( > 1)
We should only use PS Ratio as one of the criteria to value a growth stock without earnings.
Other criteria to consider are the competitive moat, the management team, the confidence of institutional investors, the debt of the company , the macroeconomic climate ( interest rate) etc…
Refer to my post on Part 1 of What are Bubble Stocks ?