Vivek, (Basantji,)
Good ... that was the weak link and you caught it !!
On same cost price (total capital employed) if profit margins are 10% ... then sale price would also be higher but not by 10% ... it might be by 3-5% (depends on how much is the absolute profit margin of that company)
I initially wanted to take that example .. but later for sake of simplicity - i overly-simplified it ... and you correctly caught it !!
But lets say that market is giving lower PE to company A than company B eventhough the profit margin of company A is more ... [Can be because B is sector leader, etc.]
Then this ratio DECIEVES YOU ... since for company A, sales are 3-5% higher and because of lower PE - market price of company A would also be 3-5% lesser ... in effect the ratio market-cap/sales for company A would have lesser numerator and higher denominator ... and this RATIO WOULD WORK AGAINST YOU AS IT WOULD INCORRECTLY SHOW THAT COMPANY B IS BETTER !!
EVEN THOUGH COMPANY A IS BETTER ON 2 COUNTS - A) lower PE b) higher profit margins !!
But here 2 positives of companies cancel each other (in numnerator and denominators) and becomes an ARTIFICAL NEGATIVE FOR THAT COMPANY !!
Some ratios tell somethings and not everythings ... But this ratio is telling WRONG THINGS !!
Basantji ?
Edited by prosperity - 26/Mar/2007 at 11:48am
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i have been trying to evaluate it but allways come to the wrong figure is it this P/S = (Stock Price) / (Sales Per Share) = (Market Capitalization) / (Total Sales)
