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    AAII's Low Price-to-Sales Screen: Strong Performer in Mixed Market

    by John Bajkowski

    AAII's Low Price To Sales Screen: Strong Performer In Mixed Market Splash image

    While Kenneth Fisher first popularized the use of price-to-sales ratios for stock selection in his 1984 book “Super Stocks” (McGraw-Hill Trade), price-to-sales ratios truly came in fashion during the Internet stock bubble as investors sought out ways to value stocks whose negative earnings rendered earnings-based models useless. Price-to-sales ratios (current price divided by the sales per share for the most recent 12 months) continue to be a useful stock selection approach even though most of the Internet stocks of the 1990s have faded away.

    Proponents of the price-to-sales ratio argue that earnings-based approaches to selecting stocks are inferior because earnings are influenced by many management assumptions trickling through the accounting books. In addition, temporary developments such as costs incurred in the rollout of a new product or a cyclical slowdown can influence earnings more than sales, often leading to negative earnings.

    Price-to-sales figures are not perfect. Some industries traditionally sell with low price-to-sales ratios. A simple screen for just low price-to-sales ratios will tend to turn up many of these firms. A low price-to-sales ratio screen that considers industry factors is built into Stock Investor Pro, AAII’s fundamental stock screening program and research database. The screening criteria are:

    • The current price-to-sales ratio is less than the company’s average price-to-sales ratio for the last five years;

    • The price-to-sales ratio is less than the median price-to-sales ratio for the respective industry;

    • The annual compound growth rate in sales for the last five years is greater than the median sales growth rate for the respective industry;

    • The total-liabilities-to-assets ratio for the last fiscal quarter is less than the industry median total-liabilities-to-assets ratio;

    • The relative price strength index over the last 52 weeks is greater than the industry median;

    • The market capitalization for the last fiscal quarter is greater than or equal to $50 million;

    • The stock must be exchange listed;

    • The company is not in the financial or real estate operations industries; and

    • The company is not a foreign an ADR/ADS stock—a foreign company listed on a U.S. exchange.
    Figure 1.
    Screen Performance
    CLICK ON IMAGE TO
    SEE FULL SIZE.


    The companies passing the screen, along with a simple hypothetical portfolio, have been reported and tracked on AAII.com for the last five and a half years. The low price-to-sales screen has produced consistently strong performance, with no down year through a mixed market environment. As revealed in Figure 1, it has easily outpaced both the small- and large-company indexes over the study period.

    FIGURE 1. Screen Performance (Performance vs. Benchmarks)
      Return (%)
    Cum’l Best
    Month
    Worst
    Month
    YTD
    ‘03
    ‘02 ‘01 ‘00 ‘99 ‘98
    Low Price-to-Sales* 224.6 14.8 -17.8 32.3 1.3 43.3 23.3 21.1 13.2
    S&P 500 10.4 9.8 -14.5 13.7 -22.1 -11.9 -9.1 21.0 28.6
    S&P MidCap 400 58.8 12.1 -18.6 16.4 -14.5 -0.6 17.5 14.7 19.1
    S&P SmallCap 600 34 13.4 -19.3 18.8 -14.6 6.5 11.8 12.4 -1.3
    All Exchange-Listed Stocks 85.2 23.9 -20.2 43.5 -13.3 21.2 -14.2 35.1 5.9

    The characteristics of the stocks passing the low price-to-sales screen are presented in Table 1, while Table 2 lists the current roster of passing companies. The screen takes a sales-growth-at-a-reasonable-price approach to filtering stocks, but looks to industry norms instead of overall market averages for its growth and value guidance. At 19.9, the price-earnings ratio (share price divided by earnings per share) of the low price-to-sales stocks is above the median figure of 17.9 for all exchange-listed stocks. In contrast, both the price-to-book ratio (share price divided by shareholders equity per share) and price-to-sales ratio are below average.

    TABLE 1. Current Portfolio Characteristics
      Price-
    to-
    Sales Screen
    Exchange-
    Listed
    Stocks
    Price-earnings ratio 19.9 17.9
    Price-to-book ratio 1.31 1.73
    Price-to-sales ratio 0.54 1.36
    EPS growth rate (hist 5 yr) -0.4% 1.80%
    EPS growth rate (est 3–5 yr) 17.50% 14.20%
    Market cap (million) $219.00 $241.40
    Relative strength vs. S&P 28.50% 9.00%
    Monthly Observations
    Average no. of passing stocks 48
    Highest no. of passing stocks 82
    Lowest no. of passing stocks 18
    Monthly turnover 42%

    The screen looks for companies exhibiting sales growth above the norm for their industry. The companies currently passing the screen have a shown a 0.4% annual decline in earnings per share over the last five years, while all exchange listed stocks have seen annual earnings grow at a 1.8% rate over the same timeframe. However, looking forward, the consensus earnings growth rate estimate over the next three to five years is slightly higher for stocks passing the low-price-to-sales screen. The median market cap (share price times number of shares outstanding) for the stocks passing the price-to-sales screen is $219.0 million, near the median for exchange-listed stocks. The stocks currently passing the screen have outperformed the S&P 500 by 28.5% over the last 52 weeks.

    Thirty-nine stocks currently pass the screen, near the average of 48 observed over the last five and a half years.

    Table 2 ranks the passing stocks by their current price-to-sales ratios. Price-to-sales levels are tied to expectations of future company growth, profitability, and risk. The higher the expected growth, the higher the price-to-sales ratio a stock can support. Higher profit margins also translate into high price-to-sales ratios. Profit margins measure the level of income produced for a given level of sales.

     

     

    Novamerican Steel has the lowest price-to-sales ratio with a figure of 0.14, and the second lowest historical growth in sales at 3.0% annually over the last five years. Its price-to-sales ratio is below the iron and steel industry median of 0.2, but its low 3.0% annual sales growth is well above the industry median growth rate of 0.4%. While its net profit margin (net income divided by sales) is just 3.5%, most stocks in the industry are losing money.

    At the other end of the spectrum are four biotech stocks. The median price-to-sales ratio for the biotech industry is 4.7. SangStat Medical’s price-to-sales ratio of 4.61 is just below the norm for biotech firms. SangStat specializes in medicines that prevent the immune system from rejecting transplanted organs. Its sales have expanded from $4.5 million in 1997 to $120.1 million in 2002, a 92.9% annual growth rate. SangStat had its first profitable year in 2002. Over the last four quarters it has earned $7.5 million on sales of $127.9 million, resulting in a 6.0% profit margin. The typical biotech stock lost 24 cents for every dollar of sales over the last four quarters. These company fundamentals help to make SangStat an attractive company in its industry—attractive enough to solicit a tender offer on August 4, 2003, by Genzyme to acquire SangStat.


    John Bajkowski is AAII’s financial analysis vice president and editor of Computerized Investing.


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