Researches have found that the stocks at historical low price-to-sales and price-to-book ratios outperform the market in long term. The performances of GuruFocus’ low P/S and low P/B model portfolios clearly support this finding.
In his book What Works On Wall Street, James P. O'Shaughnessy examined all the measures that most investors rely upon, including price-to-sales ratios, P/E's, Price-to-cash-flow, Price-to-Book, etc. The results showed that the strongest and best indicator of solid appreciation stocks were low Price-to-Sales Ratios. The concepts of low Price-to-Sales Ratios were pioneered by Ken Fisher in Super Stocks. Low Price-to-Sales Ratios stocks sell for low multiples of their sales revenue.
In order to invest in only companies with consistent business performance, GuruFocus added the requirement of high business predictability when creating the portfolio of historical low P/S portfolios. Therefore, GuruFocus requires that not only the companies are sold at historical low price-to-sales ratios, but also they have consistent and very predictable business performances.
At the beginning of the year, GuruFocus released the new screens of stocks at historical low P/S and P/B ratios. The performances of these stocks are monitored with two model portfolios, one for historical low P/S stocks, the other for historical P/B stocks.
The P/S model portfolio consists of the top 25 stocks from the historical low P/S screen. These companies have at least 4-star business predictability, have been very predictable in their business operations, their sales and earnings have consistently grown for at least the past decade. However the price/sales (P/S) ratios of these companies are less than 30% above their historical lows.
The P/B model portfolio consists of similar stocks, except the valuation is based on historical P/B ratio instead of P/S.
Since these companies have been quite consistent with their business operation, when they are at historical low valuations as measured by price/sales ratio or price/book ratio, we expect that over long term, their valuations will reverse to the historical mean. They will provide good defense in a down market, and still have good up side potential in up market.
So far in the first quarter of 2010, the S&P500 is up about 4.6%, the two model portfolios showed good defensive performance. These are the performances of the portfolio relative to the S&P500 in the first month.
P/S Portfolio, up 8.04% in the first month, outperforms S&P500 by 3.42%:
Family Dollar Stores Inc. (FDO) and Lakeland Bancorp Inc. (LBAI) are among the best performing stocks in this portfolio, up 32.7% and 38.97%, respectively. The worst performing stocks are Granite Construction Inc. (GVA) and Verizon Communications Inc. (VZ), down 9.42% and 8.33%, respectively.
P/B Portfolio, up 6.77%, outperforms S&P500 by 2.15%.
Many of the stocks in this portfolio are the same as the ones in the low P/S portfolio. It is not surprising that the companies that are sold at historical low P/S ratios are also sold at historical low P/B ratios.
The charts of these two portfolios show that they do not decline as much in the market down days. That is the main reason they outperformed.
3 months is certainly too short to prove any strategy, but if you buy good companies on the cheap, you have better chances for outperforming. The newly released historical low P/S and P/B screens are for you to find these stocks.
The holdings in the model portfolios and the screens are just some of the many premium features we provided for Premium Members. If you are not a Premium Member, you are invited for a 7-day Free Trial.