God is a Capitalist

Tuesday, September 9, 2014

Another Omen - Price to Sales

The first indicator most investors check in order to begin to assess the value of the overall stock market is the price/earnings (PE) ratio, which is currently around 18 and just slightly higher than the 60-year average of 16.3. 

But the PE ratio can change a lot depending on the number of years one selects to calculate the average. For example, the Schiller ratio uses a 10-year moving average and calculates the ratio at 26.3. As the last post disclosed, corporations have been buying back their own stock and that alters the ratio by reducing the number of shares divided into profits. 


And as Eric Fry of the Free Market Cafe relates in his post Death of an Immortal, corporations often massage the numbers to boost quarterly profits. But it's much more difficult to manipulate sales data. Fry recommends keeping an eye on it instead of the PE ratio:
 So what are price-to-sales ratios telling us right now?
They are telling us that U.S. stocks are not merely pricey, but very pricey… and not merely very pricey, but very, very pricey, relative to a few other relevant metrics. 
The price/sales ratio is currently around 1.8, the highest level since the dot-com bubble of 1999. The biggest jump took place in 2013.

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