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Stock prices relative to sales are higher than they have ever been this century.
S&P 500 Price to Sales Ratio
This is the time of year when market pundits make their proclamations for the coming year. Their expectations are usually within one of two categories: that the stock market will return 8% to 10% during the coming year, or that whatever it did in the previous year will continue. Their rationale typically includes a belief that strong corporate earnings will drive prices higher, and that low interest rates will make it so that investors have nowhere else to go except the stock market. That last point is perhaps the most ludicrous and false that I hear, but that’s another rant for another day.
The chart above shows you one of many reasons why all the standard fortune-telling described above is unlikely to happen, and why investors should not fixate on recent, past performance or on the behavior of the market averages. As it turns out, the “market” (S&P 500) is historically expensive. Check that, it is outrageously expensive. The chart shows why, in pretty clear terms.
Now, investment pros can talk about earnings all they want. But earnings can be manipulated by a good CFO as much as any data point in a company’s income statement. Sales have always been a corporate reporting statistic that is closer to the truth. That is why, while one can make an argument that stock prices could go higher as corporations squeeze out more profits from the new tax environment, technological efficiencies, reductions in their workforce, etc., this chart of prices versus the last 12 months’ reported sales is a big, flashing warning sign, especially to the extent that you own stocks whose valuations on this measure are abnormally high. The PS ratio of the S&P 500 was recently at 2.26, versus a long-term median of less than 1.50. So generally speaking, anything over 2.00 would seem to be on the expensive side.
- The 20 largest S&P 500 companies show a wide range of PS ratios. While part of this owes to the valuation investors place on one industry over another (tech stocks would likely get higher PS ratios than Utilities and Consumer Products companies, for instance), this is a pretty striking table. Only 5 of the 20 have a PS ratio of below 2.00. And, 8 of them are over 4.00. Translation: investors are paying way, way up for a dollar of sales, particularly for the so-called FANG stocks.
Price-Sales Ratios for the 20 Largest S&P 500 Components
- Many of 2017’s best performers now have extremely high PS Ratios. You see some double-digit PS ratios here. And, while a company with excellent sales momentum can “grow into” a high PS or price-earnings multiple, the risk that it doesn’t can be costly to the investor. Half of these 20 companies have PS ratios over 7.00, so while their stock prices have had a superb run, they are the opposite of cheap on a PS basis
Price-Sales Ratios for the 20 Best-Performing S&P 500 Stocks in 2017 (through 12/18/17)
- Other findings. I also found that smaller cap stocks within the S&P 500 are generally more reasonably-valued based on PS ratios. This is not surprising, given that small caps have generally underperformed large caps recently. And as you would expect, many of the lowest PS ratios are found within sectors that lagged the broad market indexes over the past year. These include Energy stocks and some Healthcare and Consumer companies.
Obviously, I have just scratched the surface. But I plan to continue scratching further on this, because a responsible investor cannot ignore charts like the first one shown in this article. The market is expensive on many measures, which is yet another reason why I believe that 2018 will be a year in which valuation-sensitive investors will be in much better position to perform than those who pay up for profits and sales that may not be realized in the economic environment ahead.
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Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors.