Expected growth rate
= Retention ratio * Return on Equity
= Retention Ratio *(Net Profit / Sales) * ( Sales / BV of Equity)
= Retention Ratio * Profit Margin * Sales/BV of Equity

Aswath Damodaran
125
Price/Sales Ratio: An Example
High Growth Phase
Stable Growth
Length of Period
5 years
Forever after year 5
Net Margin
10%
6%
Sales/BV of Equity
2.5
2.5
Beta
1.25
1.00
Payout Ratio
20%
60%
Expected Growth
(.1)(2.5)(.8)=20%
(.06)(2.5)(.4)=.06
Riskless Rate =6%
PS =
0.10 * 0.2 * (1.20) * 1
−
(1.20)
5
(1.12875)
5
"
#
$
%
&
(.12875 - .20)
+
0.06 * 0.60 * (1.20)
5
* (1.06)
(.115 -.06) (1.12875)
5
'
(
)
)
)
*
+
,
,
,
=
1.06

Aswath Damodaran
126
Effect of Margin Changes
Price/Sales Ratios and Net Margins
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2%
4%
6%
8%
10%
12%
14%
16%
Net Margin
PS Ratio

Aswath Damodaran
127
Price to Sales Multiples: Grocery Stores - US in January
2007
Net Margin
5
4
3
2
1
0
-1
-2
-3
PS_RATIO
1.6
1.4
1.2
1.0
.8
.6
.4
.2
0.0
-.2
Rsq = 0.5947
WFMI
ARD
RDK
SWY
WMK
AHO
OATS
PTMK
MARSA
Whole Foods
: In 2007: Net Margin was 3.41% and Price/ Sales ratio was 1.41
Predicted Price to Sales = 0.07 + 10.49 (0.0341) = 0.43

Aswath Damodaran
128
Reversion to normalcy: Grocery Stores - US in January 2009
Whole Foods
: In 2009, Net Margin had dropped to 2.77% and Price to Sales ratio was down to 0.31.
Predicted Price to Sales = 0.07 + 10.49 (.0277) = 0.36

Aswath Damodaran
129
And again in 2010..
Whole Foods
: In 2010, Net Margin had dropped to 1.44% and Price to Sales ratio increased to 0.50.
Predicted Price to Sales = 0.06 + 11.43 (.0144) = 0.22

Aswath Damodaran
130
Here is 2011…
PS Ratio= - 0.585 + 55.50 (Net Margin)
R
2
= 48.2%
PS Ratio for WFMI = -0.585 + 55.50 (.0273) =
0.93
At a PS ratio of 0.98, WFMI is slightly over valued.

Aswath Damodaran
131
Current versus Predicted Margins
One of the limitations of the analysis we did in these last few pages is the
focus on current margins. Stocks are priced based upon expected margins
rather than current margins.
For most firms, current margins and predicted margins are highly correlated,
making the analysis still relevant.
For firms where current margins have little or no correlation with expected
margins, regressions of price to sales ratios against current margins (or price to
book against current return on equity) will not provide much explanatory
power.
In these cases, it makes more sense to run the regression using either predicted
margins or some proxy for predicted margins.

Aswath Damodaran
132
A Case Study: Internet Stocks in January 2000
ROWE
PPOD
TURF
BUYX
ELTX
GEEK
RMII
FATB
TMNT
ONEM
ABTL
INFO
ANET
ITRA
IIXL
BIZZ
EGRP
ACOM
ALOY
BIDS
SPLN
EDGR
PSIX
ATHY
AMZN
CLKS
PCLN
APNT
SONE
NETO
CBIS
NTPA
CSGP
INTW
RAMP
DCLK
CNET
ATHM
MQST
FFIV
SCNT
MMXI
INTM
SPYG
LCOS
PKSI
-0
10
20
30
-0.8
-0.6
-0.4
-0.2
AdjMargin
A
d
j
P
S

Aswath Damodaran
133
PS Ratios and Margins are not highly correlated
Regressing PS ratios against current margins yields the following
PS = 81.36
- 7.54(Net Margin)
R
2
= 0.04
(0.49)
This is not surprising. These firms are priced based upon expected margins,
rather than current margins. Consequently, there is little relationship between
current margins and market values.

Aswath Damodaran
134
Solution 1: Use proxies for survival and growth: Amazon in
early 2000
Hypothesizing that firms with higher revenue growth and higher cash balances
should have a greater chance of surviving and becoming profitable, we ran the

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