148 ShowMetheMoney
mean more earnings. A company cannot grow faster than its sales,
but it can grow more slowly with poor management, which will be
reflecte din poor efficiency an dperformance ratios.
The sales figure is also less affecte dby accounting conventions.
Since it is the top-line number on the income statement, pretty
much the only accounting rules affecting sales relate to the timing
of their recognition. While that can be manipulate dto an extent (this
is discussed further in Chapter 10), it is far purer than the bottom-
line earnings number, which can be affecte dby scores of accounting
conventions.
Calculate theprice/sales ratio (P/S ratio)by dividing the stock
price by the sales per share (this is not commonly reporte din finan-
cial statements but is an easy calculation to make). Alternatively, you
can follow the conventional but equivalent metho dof divi ding the
total market capitalization (price times shares outstanding) by the
total sales. Either way, if you can buy a stock for a price that is equal
to or less than the company’s sales, you are on your way to getting
a goo dmargin of safety.
In our group, Microsoft is richly price dcompare dto its sales at
a P/S ratio of about 20, with Amazon.com also heftily price dat about
15, an dGE at about 5. No bargains exist on these numbers, but
again, if you can fin da company with a low P/S ratio, particularly
one that also has high profit margins, you are getting goo dvalue for
money.
Price/Earnings Ratio
Investors commonly use market prices to compare businesses by re-
lating trading prices to earnings per share. This is called theprice-
earnings ratio (P/E ratio), and it is computed by dividing the market
price of a share of common stock by the company’s earnings per
share. The limitations of using the earnings multiple for valuation
an dthe ruthlessness require dto specify a cap rate explain the pop-
ularity of P/E ratios as guides for selection.
In general, higher P/E ratios suggest that investors are more op-
timistic about a company’s prospects than they are about comparable
businesses with lower P/E ratios. The historical breakpoint for high
an dlow P/E ratios has been 15—above that was high, an dbelow it
was low. Very high P/E ratios (anything above 50) imply loads of
optimistic investors swooning over a company’s prospects. However,
the relative levels of P/E ratios also vary with a company’s growth out-