When you don’t find a relationship

P/E and P/S ratios

Don’t worry, I’m not pivoting into a relationship advice blog. (But, if the readers eventually demand such a thing, who am I to deny the people what they want?)

I’m talking about quantitative relationships between metrics. Specifically, the Price-to-Earnings ratio and the Price-to-Sales ratio.

One might expect there to be some kind of connection between the two. After all, both use price as the numerator and divide that with either revenue (sales) or net income (earnings). And, net income is just a few steps away from revenue on the income statement.

Well, if you are dumb like me and expected the two to play nice, you’d be mistaken:

There is certainly no linear relationship here. If you remove even more of the noise than I already did and use a non-linear fit then maybe you’d get something. But, if you wanted a neat connection then, like some relationships in life, things can get complicated!

A lack of relationship is also useful information though. If these two metrics had a strong linear correlation then that would reduce the efficacy of using both. Since they behave differently enough, there is valuable information that can be gained by using both metrics. So, sometimes incompatibility isn’t such a bad thing!