Are Some Stock Prices Destined to Fall?

Abstract

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.