The Secret Metric Smart Investors Use for Growth Stocks

🔑 Key Takeaways:

• When a company is unprofitable or just turned profitable, traditional valuation methods don’t work. That’s where the EV/Sales ratio comes in.

• This new method, now available in Forecaster, helps identify whether fast-growing businesses are fairly valued or overhyped.

• I recently used it to sell Palantir and buy On Holding. Here’s why.

Why Traditional Valuation Methods Don’t Always Work

Let’s be honest, when you’re analyzing a fast-growing company like Duolingo or Palantir, most traditional valuation models like Discounted Cash Flow (DCF), Economic Value Added (EVA), or the Peter Lynch method often give you very strange results. Why? Because these models are based on net income and that’s a problem when profits are still unstable or negative.

In these cases, we need something simpler. Something that focuses on what the company is already doing well: growing its sales.

The Method: EV/Sales for High-Growth, Low-Profit Companies

So what is this new way of calculating the fair value that Forecaster now provides?

It’s based on the Enterprise Value-to-Sales (EV/Sales) ratio. The idea is straightforward: how much are investors paying for each dollar of a company’s sales?

Here’s the formula:

EV/Sales Ratio = Enterprise Value / Annual Revenue

And the Enterprise Value (EV)? Also simple:

EV = Market Cap + Total Debt – Cash

Let me give you a real-world example. Think of it like buying a shop. If you’re buying a store, you’ll pay not just the price the owner is asking (market cap), but also take over their debt. On the other hand, if there’s cash in the register (cash on hand), that goes to your benefit so you subtract it.

Now, the beauty of this model is that it doesn’t care about net income. It focuses only on how fast the business is growing revenue. This is perfect for companies investing heavily in marketing and R&D to grow fast, even if they’re not showing big profits yet.

Case Study #1: Duolingo – A Fairly Valued Growth Story

Let’s talk about Duolingo. We’ve covered this company before, and now it’s finally turned a profit. But it’s still investing aggressively to grow, especially in R&D and AI-driven features. If we try to value Duolingo using DCF or the Peter Lynch method, we get wildly different results that don’t align with the current stock price.

[DUOLINGO DEEP DIVE UPDATED SEPTEMBER]

But when we apply the EV/Sales method? Suddenly the numbers make sense. The fair value matches almost perfectly with the current market price. That’s a huge insight. Because now we can say with confidence: Duolingo is fairly valued right now, even if its net income is not impressive.

This change alone, introducing EV/Sales into Forecaster, has helped us better understand companies like Duolingo that are in a fast-growth phase. Net income might still be volatile, but sales are booming, and that’s what this method rewards.

Case Study #2: Palantir – Overhyped and Overvalued

Now let’s flip the script.

Take Palantir. Another fast-growing company that finally turned a profit in 2023. If you only look at headlines or social media hype, it looks like a great stock to hold. But when we apply the EV/Sales method, the story changes.

Palantir is trading at a price that is more than 45% higher than what we would consider a fair value using this approach. Even if we remove the Peter Lynch method from the analysis, known for being aggressive, the EV/Sales calculation still shows a big overvaluation.

Just look at the numbers:

• Peter Lynch says fair value is around $22

• EV/Sales says it’s about $86

• But the actual stock price is $158

That’s a massive gap. In my opinion, this is all driven by AI hype, not fundamentals. That’s why we decided to sell our position in Palantir. It’s just way too expensive at the moment.

The Company I Just Bought: On Holding (Ticker: ONON)

Now let’s talk about the exciting part: the stock I just bought using this method: On Holding.

If you don’t know On, I really suggest watching the CNBC video titled “How On Running Shoes Are Taking on Nike and Adidas.” It’s eye-opening. They’re doing something completely different, not just making shoes, but reinventing the way shoes are made.

They’ve developed a robotic system that sprays material onto a mold and builds a shoe in about three minutes. That’s huge. It means they can move production anywhere, like to the U.S., if tariffs become an issue. No more dependency on cheap labor.

And what’s even more interesting is that I started noticing people wearing On shoes everywhere, from Greece to Asia to the U.S. I thought maybe it was just a Swiss thing (since the company is based in Zurich), but no. It’s a global trend.

So I ran the numbers.

On Holding by the Numbers

When we analyze On Holding in Forecaster using only the EV/Sales method, here’s what we see:

• The company is currently about 13% overvalued, which is minor.

• Sales are growing fast year over year.

• The company just turned a profit two years ago, making it a perfect fit for this method.

• They’re investing in innovation, not cutting corners.

• And yes, Roger Federer is one of the biggest investors (he owns about 3% of the company).

They are not doing buybacks right now, in fact, they’re issuing new shares, which is something I don’t love. But even with that, the company is growing its efficiency, and once buybacks start, I believe we’ll see a serious stock price surge.

It’s interesting how our Market Mood Meter, in the Overbought/Oversold page of Forecaster, is also starting to show a divergence, rising while the price is falling. This indicates that buyers are not decreasing, but actually increasing as the price goes up.

The Bigger Picture: Undervalued and Ready to Grow

On Holding currently has around $2 billion in annual sales, while Nike is doing $46 billion. That means On still has a massive market to conquer.

And with a unique product, strong brand momentum, and real tech innovation, this company is not just another shoe brand. It’s building something fundamentally different.

In terms of fundamentals, yes, the net income isn’t exciting right now. But that’s fine. This is not a company to value on net income. This is a company where sales growth is the key. And from what I see, sales are not just growing, they’re accelerating.

So that’s why I’ve opened a long position in On Holding.

Final Thoughts

This new EV/Sales-based valuation method has completely changed the way I analyze high-growth stocks. It’s now available in Forecaster, and I truly think it’s the best way to evaluate companies like Duolingo, Palantir, and On Holding, especially when profits are still catching up with revenue.

If you’re serious about investing in growth stocks, stop relying on net income and start looking at sales and enterprise value. The picture becomes much clearer.

And of course, if you want to know what’s happening with a specific stock, just click the Forecaster AI agent and ask “What’s happening?” You’ll get a full breakdown, bullet points, sentiment, fundamentals, and more.

For now, I’m holding Duolingo and On Holding in my portfolio. And I’ll keep using this method to evaluate any company that’s still in its early phase of hypergrowth.

Let me know what company you’re analyzing next, I’d love to help you break it down using this method.