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November, 2014


Often forgotten in the quest for easy to apply metrics in stock valuation, price-to-sales or the P/S ratio (PSR) has a lot going for it. If a publicly held business is to be profitable, it must sell stuff. Whether it sells enough goods, commodities, or services to offset its costs is crucial to determining if there will be real earnings, book value, or dividends, other measures of shareholder value, in relation to its price in the public marketplace. Price-to-sales is a hard to fudge fundamental factor in future success or failure for the publicly traded company. The definition is merely the total market value (total shares times the latest cost per share on a stock exchange) divided by the total sales of the company over the just prior reporting year. This can be expressed more simply as the price per share divided by the sales per share.

Compared with an all domestic stocks index mutual fund average annual return of about 11%, a low PSR by itself can be valuable to use in stock selection, providing average annual returns of around 16%, according to What Works On Wall Street by James P. O'Shaughnessy (p.136, McGraw-Hill, New York, 1997). He considered it the best single stock value measure. Low P/S was defined as the 50 stocks with the lowest PSR from an all domestic stock universe, starting on the last day of 1951 and continuing through the last day of 1994, rebalanced annually to assure inclusion of the lowest 50 by P/S each year.

Yet a stock need not be selected based on price-to-sales alone. It can be the foundation of an overall value approach and provide even better average results. I favor this latter method and give particular emphases to P/S of 0.5 or below, debt to equity of 0.99 or below, reasonable return on equity, price to earnings, and price to book value ratios, and positive price momentum.

The following stocks meet this overall set of criteria.

Air T, Inc.AIRT$16.330.3514.10-1.344.60%9.69%+42.50%
Cash American International, Inc.CSH$24.760.387.015.470.6362.10%9.51%+44.60%
Core-Mark Holding Co., Inc.CORE$57.430.1731.0021.902.9714.23%9.84%+56.20%
Sanmina Corp.SANM$24.280.3310.709.831.6243.88%16.86%+55.64%
Wayside Technology Group, Inc.WSTG$17.570.2512.70-2.150.00%17.84%+35.05%

There are no guarantees, but in the past a portfolio of 25 such stocks, rebalanced annually, averaged total annual returns of over 20%. It is recommended that one gradually acquire the better stocks available meeting these guidelines, for instance about 2-3 per month till achieving the 25-stock low P/S portfolio, then simply sell off those already held a year and a day (to avoid short-term tax rates) that no longer meet the criteria, replacing them with new stocks that do.

It can be legitimately argued that stocks overall are not so low in price these days and that one cannot therefore expect them to provide historical levels of average return. Yet in my opinion the above investment plan is superior enough to simply buying the market (for instance through mutual funds or exchange-traded index funds) that even if stocks in general do not perform that well, the indicated procedure can still offer 5-10% a year of higher average returns than the major market indexes provide. For instance, if the S&P 500 Index gives price appreciation plus dividend income of only 6% a year over the next decade, this stratagem could well provide total returns averaging 11-16% in the same period.

One caution: the strategy is not without risk, and prices of its picks can fall significantly in a bear market. If one is ready to stick with the technique, though, it is likely to provide excellent long-term rewards.

Good luck.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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