Thread by @ycharts

YCharts recently caught up with @brianferoldi & @Brian_Stoffel_ to discuss "Everything Wrong With The P/E Ratio" & we learned some great insights on alternative valuation metrics that we’re excited to share. Let's take a look at $NFLX as an example:

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The PE ratio isn't always appropriate for every company during its growth cycle. Let's look at $NFLX, a known disruptor company with humble beginnings. The company experienced hyper-growth, before finally maturing into the household name we all recognize today.

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Because the PE ratio doesn’t factor in future growth potential, it’s not the best ratio to use in the early days of companies like $NFLX. For example, the chart below shows #Netflix’s PE ratio in orange during infancy, a whopping 1459.79. Why?

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In its early days, $NFLX experienced a lot of #volatility, like many up-and-coming companies, that resulted in low net-earnings compared to its share price. Feroldi & Stoffel say based on the PE ratio alone, an investor in 2004 might assume that Netflix is likely overvalued.

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What metric would be more helpful in evaluating a growing company? The Price-to-Sales ratio is ideal when companies are optimized for revenue growth. Another option is the Price-to-Gross Profit ratio. Both are shown below to demonstrate how they differ from the PE ratio:

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How can #investors use these ratios to their advantage? In the first 10 years of $NFLX's growth cycle, its average PE ratio was about 105 while its average PS & PEG ratios averaged over 2.5 & just under 1, respectively, indicating it could've been a reasonable #investment.

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@brianferoldi & @Brian_Stoffel_ shared this visual as a guide to the best valuation ratios for each stage of a company’s growth. To identify which stage a company is in, Feroldi recommends looking at revenue & free cash flow growth rates:

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Don’t want to miss other #YCharts insights? Be sure to catch our webinar TODAY at 12:30PM ET/11:30AM CT with @MichaelKitces as he discusses all things #risk tolerance for retiring #clients.

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