Why Buying Speculative Stocks Is A “Distinctly Inferior strategy”

Why Buying Speculative Stocks Is A “Distinctly Inferior strategy”
Andrew Rummer

almost 3 years ago1 min

Investors are showing record enthusiasm for smaller companies whose value is based on a grand vision of a bright future and could get better returns in less speculative stocks, according to a new report from research firm Leuthold.

The black line on the chart above shows how the proportion of companies in the Russell 2000 – an index of smaller US stocks – with a price-to-sales (P/S) ratio greater than 15 has climbed to the highest level since the dot-com bubble.

The dashed red line shows what happens when you also add in companies that generate zero revenue – which are missed when screening for high-valuation stocks even though their P/S ratio is technically infinite. This measure stands at a record high, well above the dot-com peak. 

Leuthold notes that investors are showing “abundant enthusiasm for companies whose success depends on a brilliant future rather than a successful today.” And they warn that “buying vision stocks trading at very high P/S multiples has been a distinctly inferior strategy over time.” 

Looking back over the past 30 years, Leuthold found an average annualized return of 11% for the Russell 2000 overall – but just 2.6% for small stocks with a P/S ratio over 15. 

Be careful before you buy into the hype surrounding many stocks with eye watering valuations. 

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