Anchoring valuation on a company's typical price-to-sales ratio helps identify buying opportunities when margins are temporarily depressed. This avoids the pitfalls of methods like the Magic Formula, which can mistakenly favor companies at their cyclical earnings peaks, leading to underperformance.
Cisco's stock took 25 years to reclaim its year-2000 peak, despite the underlying business growing significantly. This serves as a stark reminder that even a successful, growing company can deliver zero returns for decades if an investor buys in at an extremely high, bubble-era valuation.
Speculative manias, like the AI boom, function like collective hallucinations. The overwhelming belief in future demand becomes self-fulfilling, attracting capital that builds tangible infrastructure (e.g., data centers, fiber optic cables) long before cash flows appear, often leaving lasting value even after the bubble bursts.
Investors often invent compelling secular narratives—like a permanent housing shortage or "Zoomers don't drink"—to justify recent price movements. In reality, these stories are frequently post-hoc rationalizations for normal cyclical fluctuations. The narrative typically follows the price, not the other way around, leading to flawed trend extrapolation.
Michael Burry's thesis is that aggressive stock-based compensation (SBC) at companies like Nvidia significantly distorts their valuations. By treating SBC as a true owner's cost, a stock appearing to trade at 30 times earnings might actually be closer to 60 times, mirroring dot-com era accounting concerns.
Despite record market highs, the S&P 500's underlying earnings per share (EPS) have not yet recovered to their peak from early 2022. This "narrative violation" points to a hidden earnings recession for large-cap stocks, a fact that has been masked by market enthusiasm and multiple expansion.
The S&P 600 small-cap index has massively outperformed the more popular Russell 2000. The key difference is the S&P 600's requirement for profitability, which screens out speculative, pre-revenue "junk" companies that drag down the Russell 2000's returns, especially during speculative bubbles.