Are Some Stock Prices Destined to Fall?
Journal of Applied Finance, Spring/Summer 2012, Volume 22, Issue 1, pp. 144-160
Posted: 29 Jul 2012
Date Written: 2012
This paper shows how to quantify the growth expectations underlying a firm’s stock price from its price-to-sales (P/S) ratio. This approach reveals that high P/S firms (e.g., P/S>10) face tremendous growth expectations: they must increase the scale of their operations by a multiple of 10, 20, or more to justify their stock prices. Because typically only the smallest of firms can achieve sales growth of this magnitude, most high P/S firms do not fulfill expectations and suffer steep stock price declines. Many high P/S stocks lose a considerable portion of their value, even after experiencing a period of substantial sales growth. Thus, investors can use the P/S ratio to identify firms with stock prices that are likely to fall, and either avoid or short these stocks.
Keywords: Growth expectation, Stock price, Price-to-sales (P/S) ratio
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