Investing in Stocks Over 10x Price to Sales

Introduction: Price to Sales, Sun Microsystems & “A Talk with Scott McNealy”
The Pittance of Profits among the Top Decile of Price to Sales
The Catastrophic Consequences of Buying the Top Decile of PS at +1σ Levels
Conclusion: Avoid Investing in the Theatre of the Absurd

Introduction: Price to Sales & “A Talk with Scott McNealy”

Kailash Capital Research, LLC has not been shy in using Scott McNealy’s quote on April 1^st 2002 during an interview with Businessweek about his firm Sun Microsystems. While the research Kailash publishes relies on analyzing empirical facts from the past, our organization believes strongly in the interaction between quantitative processes, common sense and fundamental analysis. Kailash believes Mr. McNealy’s comment to be among the most effective examples of elocution to ever convey the obvious interaction of a data element, in this case price-to-sales (P/S), with common sense and fundamental analysis. In discussing the valuation of his own firm in April of 1999 he stated:

“…we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”¹

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Figure 1 below exhibits the P/S ratio of the most expensive decile of firms in the Russell 1000 (R1), Russell 1000 Growth (R1G) and Russell 1000 Value (R1V) indexes. History appears to be once again repeating itself.

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Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital Research, LLC and its affiliates (collectively, “Kailash Capital Research, LLC ”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital Research, LLC . In preparing the information, data, analyses, and opinions presented herein, Kailash Capital Research, LLC has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital Research, LLC , however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital Research, LLC and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital Research, LLC – All rights reserved.

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