The First Cut: Top-Line Growth and Value
by John Bajkowski
Company success starts with revenue. The ability to sell goods and services opens up the door to generate cash and earnings. The First Cut this issue screens for companies with a record of strong and consistent sales growth that are able to convert sales into above-average profits, yet are attractively valued.
The First Cut starts out looking for domestic, exchange-listed companies that have been able to increase sales for each of the last six years. Looking at recent growth, quarterly sales must also be higher than the prior years quarter over the last year.
The companies passing the First Cut are profitable and have operating profit margins above the norm for their industry. An analysis of profit margins proves most useful when comparing firms in the same industry. Industries with commodity products and high turnover typically have a lower profit margin. Firms with more specialized niche products usually have a higher margin, but lower turnover.
The First Cut screen also looks for companies trading at a price-to-sales ratio below the norm for their industry to identify firms that may have been overlooked or incorrectly assessed by the market. The 30 firms with the highest annual growth in sales over the last five years are presented in the table. The sales figure over the last 12 months indicates that most of these firms are small- to mid-sized companies. While a number of industries made the cut, there is a strong concentration of biotech firms. Historical earnings growth helps measure the success of converting sales into profits. The year-ago price-to-sales ratio provides a feel for the change in valuation over time. The 52-week price change provides an indication of price strength.
Sales growth and price-to-sales ratios are useful tools in identifying attractive companies, but industry knowledge is crucial in judging growth and price-to-sales ratios.
AAII Vice President, Senior Financial Analyst