When it comes to equity valuations, most investors are concerned with the price/earnings ratio. And while that P/E ratio has fallen to just below the average of the past decade, the picture painted by another valuation measure is much less attractive.
The chart below shows the price-to-sales ratio for US equities. And although this measure has also come down considerably in recent months, it is difficult to say that US equities are cheap. Indeed, when you take out the Covid bubble years - characterised by an incorrect extrapolation of the growth potential of US tech companies like Netflix, Zoom, et cetera, the price-to-sales ratio is still at record levels.
Inflation is the reason why the price-to-sales ratio is still so high. Investors are blinded by the strong increase in nominal(!) sales, driven by ever-higher prices. Compared to a year ago, American companies achieved a 17 percent increase in sales.
But that is not sustainable. In the two recessions before the Covid recession, US companies’ sales per share fell by 12 percent and 19 percent respectively. And during the growth slowdown between 2015 and early 2017, sales-per-share fell by 3 percent. Given that I estimate the probability of a US recession to be at least 50 percent, it is virtually impossible to sustain current sales growth.
So I have my doubts when investors claim that shares are cheap or attractively valued. The stubbornly high price-to-sales ratio does not support such a claim. The valuation is not yet attractive enough to prevent a further fall in shares.
Jeroen Blokland is founder of True Insights, a platform that offers independent research to construct diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Monday on Investment Officer Luxembourg.
This column first appeared on InvestmentOfficer.nl.