Here's a Stock-Market Tool That Isn't Used Much

P/S is a useful ratio that is not used much

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Jul 20, 2016
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Value investors live and die by ratios. One ratio that is helpful, but not used much, is the price/sales ratio – a stock’s price divided by the company’s sales (or revenue) per share.

Aetna Inc. (AET, Financial), ArcBest Corp. (ARCB, Financial), Flexsteel Industries Inc. (FXLS, Financial), Nippon Telegraph & Telephone Corp. (NTT, Financial), and Potbelly Corp. (PBPB, Financial) all sell for less than 1.0 times revenue. They deserve a serious look in my opinion.

The average stock these days sells for 2.1 times revenue. A typical ratio historically is about 1.5.

The price/sales ratio is good at pointing to companies that have a solid customer base are under-earning. These companies may be turnaround candidates, whose profits can be pepped up by new management, by selling a losing division, or by improving a key product or service.

Track Record

From 2000 through 2015 I’ve written 13 columns recommending selected stocks with low price/sales ratios. The average 12-month gain on my recommendations has been 39.9%, compared to 7.15% for the Standard & Poor’s 500 Index.

I hasten to add that a 39.9% average annual return is anomalous. It’s better than I’ve done in most of my other column series, or in real life. The return is so high largely because of outsized gains on picks I made in 2000, 2002 and 2012.

My selections have beaten the S&P 500 eight times out of 13, and been profitable 12 times out of 13.

The loss year was this past year. From July 14, 2015 through July 13, 2016, my choices declined 6.4% while the index was up 4.3% including dividends. Travel Centers of America (TA) fell 47.4%, Valero Energy Corp. (VLO) dropped 22.7% and The Andersons Inc. (ANDE) slipped 1.6%.

On the brighter side Tech Data Corp. gained 32.8% and Lear Corp. was up 6.8%.

Bear in mind that results for my column picks are theoretical and don’t reflect actual trades, trading costs or taxes. The record of my column selections shouldn’t be confused with the performance I achieve for clients. And past performance doesn’t guarantee future results.

Aetna

The Affordable Care Act requires large companies to offer health insurance, penalizes individuals who don’t have health coverage, and offers some subsidies. All this expands the marketplace for health insurers such as Aetna Inc.

It remains to be seen whether the individual policies will be profitable (the sickest individuals are most strongly incented to buy them). But the group policies are profitable, and Aetna is one of the leaders there. Its stock goes for 0.68 times sales.

ArcBest

A trucking company based in Fort Smith, Arkansas, ArcBest was known as Arkansas Best until 2014. It operates more than 20,000 trailers, with more than 4,000 tractors to pull them.

No one would claim that a trucking company isn’t cyclical. But here’s some good news: ArcBest has turned a profit in 12 of the past 15 years, has only moderate debt, pays a dividend and has room to raise that dividend. The stock fetches only 0.17 times sales.

Flexsteel Industries

A furniture maker based in Dubuque, Iowa, Flexsteel Industries Inc. sells for only 0.66 times sales. Its other valuation statistics are also reasonable, and the company is debt-free.

Why is this stock cheap? One reason may be that its revenue over the past 10 years shrank at a 1.4% annual clip. However, revenue growth has been positive 4.9% over the past five years and 7.3% over the past year so I think the company is finding its legs.

Nippon Telegraph

Nippon Telegraph and Telephone Corp. is based in Tokyo, Japan but traded in the U.S. as an American Depositary Receipt, or ADR. The stock trades at 0.86 times revenue, 13.5 times earnings and 1.1 times book value (corporate net worth per share). I consider those attractive valuations.

Telephone company shares have been popular worldwide in recent weeks, as they offer a haven of stability in a turbulent world.

Potbelly

Potbelly Corp., with headquarters in Chicago, operates approximately 400 Potbelly Sandwich Works shops in 28 states in the U.S. The company is debt-free, a characteristic I love.

Revenue and earnings are growing fast. There is always a risk with rapid expansion that quality or financial controls will deteriorate. I think the risk is worth it in this case. I like the stock at just under 1.0 times sales.

Disclosure: I own Flexsteel, Lear and Valero for most of my clients and personally. I own Aetna for most of my clients and Travel Centers of America for one client.

Correction: I misunderstood the lending program at SLM Corp., mentioned last week. SLM’s student loans are not federally guaranteed; they are part of the 7.5% of student loans that are strictly private transactions. Also, I called student lending high-risk, but the company points out that its default rate is less than 1%.

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