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URL:  https://boards.fool.com/let39s-refine-the-ps-discussion-34079518.aspx

Subject:  Let's Refine the P/S Discussion Date:  12/8/2018  7:53 AM
Author:  dumaflotchie Number:  106412 of 115741

The reason you’re hearing “valuation does not matter” is because valuations are the highest since the bubble. But so is revenue growth. This is the first time since 1999 that we have seen companies going public growing revenues at a 50% clip en masse.

OK, good discussion 12X, Tinker, Dreamer, Ethan, Volfan, AJ, Tex, Denny, Kevin, Money, Torque, Tree, Ben......its why I love the crowd sourcing of ideas that the FOOL's platform provides for us.

At least here at the NPI, I believe we are savvy enough to know that valuations do matter. There simply must be some extreme of valuation wherein, an investment makes no sense or at least lesser sense compared to alternative investment opportunities.

There can be an "illusion" that valuations don't matter during a "momentum" phase of market appreciation (like this past year), when there is too much money chasing too few investment options (perhaps what we have seen in the early SaaS craze) or when the money supply has been massively expanded (such as what had happened from 2008 forward through FED actions).

These momentum driven markets can "allow" valuations to run far and hard as money indiscriminately chases opportunities despite the irrational valuations.

Please allow me to add some color and do a little walk down memory lane:

https://www.fool.com/how-to-invest/2014/06/28/beware-of-high...

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.

This is why the table that Jon posted with % growth rates (and the FEV thread) are so important IMO.....these momentum (expanded valuation multiple) stocks MUST have high revenue growth well into the future to sustain their lofty stock prices.

Look at what happened to CSCO after it reached a P/S 35 in 2000.....an 18 year stock price contraction.....though I haven't gone back to see how its revenue growth contracted, it surely didn't maintain that high P/S for very long....less than year.

Please try to find all the stocks that have held a high P/S for many consecutive years......this is a VERY RARE event when I last looked. I would like to study your examples a bit further so offer all your lists of tech stocks that have held high P/S for 3 or more years.

One of the few I discovered was FB which maintained a P/S of 18-20 for 3 straight years from 2013 to 2015 (currently it is 7).

Let's look at the stock's annual return during these years compared to its P/S:

Year P/S % Stock Gr
2012 11
2013 21 105
2014 18 43
2015 19 34
2016 13 10
2017 14 53
2018 8 -25

You can see from this example (one of the few of sustained high P/S from 2013 to early 2016), that the stock return did dwindle in those years (the initial 105% growth was the multiple expansion which was followed by 43, 34, 10).

But please offer forth your other examples of consistently high P/S year after year so I can look at these annual stock returns in comparison.

Back in April, I posted a segmented portfolio of P/S.....the ONLY stocks with P/S at 20 and higher were SHOP (20) and ZS (21).

Their returns this year have been 33% and 21% respectively......perhaps some parallel with the FB situation.

In contrast, when we look at the real massive gain stocks this past year, they had much lower starting P/S:

MDB was 7...now 20.
TTD was 7...now 14.
TWLO was 6...now 15.

I hope I have convinced everyone that the huge gains made this year on stocks like MDB, TWLO, TTD have been through multiple expansions.....these charts are irrefutable:

https://ycharts.com/companies/MDB/ps_ratio

https://ycharts.com/companies/TTD/ps_ratio

https://ycharts.com/companies/TWLO/ps_ratio

But again the question of the hour is.....now what?? Do you still want to be holding these stocks with P/S of 20 or greater or do you want to add or take a new position??

These are my suggested conclusions (please feel free to refute them WITH DATA):

1) The highest returns will likely NOT come from the highest valued stocks.
2) The highest returns will likely NOT come form the lowest valued stocks.
3) The Highest returns will likely come from that middle tier valued stocks (P/S 6-12).
4) There may still be tax reasons to hold a stock that grew into a high valuation even if the going forward return is NOT likely to exceed other opportunities.
5) It is VERY challenging to identify and hold a stock for 10 years prospectively since one cannot know that such a stock is the next AAPL or MSFT.
6) An investor still has to identify the most promising stocks first, and then apply the above checklist.

If I could also circle back to 12X's suggestion that using the market cap to TAM can be useful. We have done a great deal of TAM assessments on our stocks here at the NPI. As readers here know, it can be very tedious work especially with the wild TAM proclamations thrown around by these companies incessantly....they are inherently unreliable.

So while few would dispute the ideal of comparing market cap to TAM and all its competitors market share (like we did ad nauseum with TNX,VMW, etc. in the past couple years)…..this data is unreliable.....too unreliable IMO to be that useful unless we have some independent confirmation of legitimate TAM outside what the companies are proclaiming.

Sorry for the long wind...will stop for now and offer a high 5 and 2 Tylenol for anyone who read this far :)
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