In 2002, after the dot-com bubble burst and Sun Microsystems swooned, the company’s co-founder Scott McNealy highlighted the folly of Wall Street analysts who favored one particular financial metric to gauge a stock’s worth: its price relative to the company’s sales.
Mr. McNealy was musing about the “price to sales” ratio — an important measure of a company’s value relative to how much cash it generates. A high ratio can be justified if investors think a company has room to grow; a low ratio typically signals that investors think the company is accurately valued.
Using that metric, analysts had gambled that Sun’s stock was undervalued even when it was trading at more than 10 times its revenue — a value its business couldn’t ultimately sustain. Even if Sun passed on every dollar it was making at the time to investors, it would have taken them a decade to recover their investment.
“Do you realize how ridiculous those basic assumptions are?” Mr. McNealy told Businessweek. “You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
The current stock market is evoking similar sentiment among some investors, led by the giant chipmaker Nvidia, the poster child of the exuberance around artificial intelligence. On Wednesday, Nvidia’s stock price closed at 27 times its sales.