“I can prove anything with statistics – except the truth,” wrote the 19th century prime minister George Canning. Critics of quantitative-led investing – in which metrics and ratios take precedence over sector expertise, views on market sentiment, macroeconomics, or close knowledge of a firm’s assets – sometimes make a similar point.
A single-digit price/earnings (PE) multiple, or a discount to net asset value, tell you something about a stock; that it’s cheap relative to peers, or its trading history, or that investors expect group equity to weaken. Such measures may be provable, incontrovertible even. But this isn’t the truth, exactly. In practice, these metrics serve only as snapshots, guides, or probabilities.
Investors therefore need to remember the limitations and misuses of any ratio, especially in isolation. And possibly nowhere is this truer than with the price-to-sales (P/S) ratio.