Are Some Stock Prices Destined to Fall?

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This paper shows how to quantify the growth expectations underlying a firm's stock price from its price-to-sales (P/S) ratio. This approach reveals that high P/S firms, defined as firms in the top 5 percent when ranked by P/S (P/S > 12.2), face tremendous growth expectations. These firms must increase the scale of their operations by a multiple of 10, 20, or more to justify their stock prices. Because typically only the smallest of firms can achieve sales growth of this magnitude, most high P/S firms do not fulfill expectations and suffer steep stock price declines. Many high P/S stocks lose a considerable portion of their value even after experiencing a period of high (but not high enough) sales growth. Thus, investors can use the P/S ratio to identify firms with stock prices that are likely to fall, and either avoid or short these stocks.

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