Heard in Texas Focusing on Sales, Not Earnings May Provide Better Returns
May 17, 2011
Forget earnings. The next Wall Street buzzword is sales. While investors religiously watch earnings news for clues on which way to push a stock, and look to price-to-earnings ratios when scavenging for bargains, new evidence suggests that focusing on the top line instead of the bottom offers a better return. That could be good news for investors in a handful of Texas companies with growing sales. The finding comes from Jami O'Remy, president of O'Shaughnessy Capital Management, in Greenwich, Conn., and the author of a new book on investing. After studying nearly 45 years of market data, Mr. O'Remy has determined that the best method for picking stocks is to find shares that have low price-to-sales ratios and whose prices have shown recent strength. ``It's a one-two punch,'' says Mr. O'Remy. ``On the sales side, you're finding the bargains, and you're buying them at a time when the Street is beginning to reassess the stocks.'' A Significant Ratio In his study, Mr. O'Remy calculated how an investor would have fared between 1951 and 2010 by spreading $10,000 among the 50 stocks with the lowest price-to-sales ratios and high price appreciation in the prior year. He rebalanced the portfolio every year. The result: an impressive 18.5% compounded annual return, worth $17.8 million today. A similar investment in the Standard & Poor's 500-stock index, by comparison, would have returned about 11.9%, or $1.4 million today. ``Price-to-sales is possibly the most significant of all the ratios for the last 45 years,'' says Mr. O'Remy, who studied many different investment strategies, encompassing both value-investing and growth-investing. (P/E ratios, by the way, turned out to be the worst of the value indicators in the study.) In Texas, applying this sales strategy uncovers stocks that cross industry boundaries, including Compaq Computer, Southern Union and Plains Resources. Why does this system work? Because other value investing tools such as earnings, cash flow and book value can all be molded in the hands of a creative financial officer, or skewed by such things as onetime charges. But sales is the one number that is most difficult to tamper with. For the most part, Mr. O'Remy says, ``a dollar's worth of sales is a dollar's worth of sales.'' Thus, valuing by PSR can uncover stocks of companies where sales are growing strongly, but the stock might otherwise look sickly simply because temporary earnings troubles have given the stock a high P/E ratio. In such a situation, ``you end up buying a dollar's worth of sales for 50 cents,'' Mr. O'Remy says. ``As the company improves its profit margins even slightly, you'll see a big increase in earnings down the road.'' And earnings, ultimately, do drive stock prices. Hunting for PSR Locating a company's PSR isn't easy. While many publications, including this one, routinely print P/E ratios, few track PSRs. Many brokerage firms, however, have access to that data, and Value Line investment survey, a stock-market newsletter available at many libraries, includes a company's per-share sales as part of its statistical array. Sales ratios also are available through some on-line investment databases. Investors can determine PSRs by dividing a company's stock price by its pershare sales (annual sales divided by shares outstanding). In general, Mr. O'Remy recommends stocks with PSRs of one or less. The S&P 500's average PSR is about 1.3. To unearth promising Texas stocks, Texas Journal tapped into Telescan, a Houston on-line investment database. Texas Journal screened for stocks with PSRs of one or below that have also demonstrated strong relative price momentum in the past year -- in this case, stocks that have advanced at least 21% in the past 12 months, which is roughly 10% better than the S&P 500. To further whittle down the list, the computer was set to search for companies that have posted healthy sales growth of at least 15% annually over the past five years. The result is a mish-mash of seven stocks, some well-known, others that aren't. While their PSRs all are low, their P/E ratios span a broad range-from a bargain of 12 to a pricey 31. No matter, Mr. O'Remy insists, ``You just have to hold your nose and buy them all. You can't cherry-pick only the names you like.'' Mr. O'Remy says investors should rebalance their portfolio every year, replacing stocks whose PSRs have moved ahead with those that have slipped to the bottom. The Magnificent Seven? And at the bottom in Texas currently: Plains Resources, CompUSA and First Cash, all of which are trading at just 0.4 times their annual sales. Here is a brief look at these and the other four companies that made the cut: Plains Resources: After suffering through the energy depression of the 1980s, Plains Resources, a Houston oil and gas exploration company, is prospering these days amid renewed interest in the oil patch. Sales have surged nearly 20% a year over the past five years. The stock has responded accordingly; shares are up to $13.625 currently from a 52-week low of $6.75 late last year. CompUSA: The Dallas computer superstore also has turned its act around after some troubling times earlier this decade. Sales have moved ahead by 24% a year on average. And though many currently fear the computer industry is slowing, annual computer sales continue to grow. As such, CompUSA's sales should continue to chug right along, too. First Cash: This small Arlington pawnshop chain has expanded its sales by nearly 33% a year on average, mainly through acquisitions of smaller pawn shops. The company also is benefiting from recently strong same-store sales growth. But with a market capitalization of less than $20 million, the company hasn't yet attracted much attention from Wall Street analysts. Southern Union: The Austin natural gas distribution company is heavily dependent on weather patterns; colder and hotter-than-normal weather push the company's sales higher. Indeed, last year, a colder winter in the company's key Texas and Missouri markets helped drive sales more than 29% higher. At $21, the shares trade at just half the company's annual per-share sales. Capstead Mortgage: The Dallas mortgage investment firm trades at 0.7 times sales. The company has had a troubled past, but has taken on a renewed shine in recent quarters. Merrill Lynch in July initiated coverage on the stock with a favorable ``accumulate'' rating, noting among other things that the stock's dividend yields an impressive 12% annually. Dell Computer and Compaq Computer: These two stalwarts of the tech sector have been growing rapidly in recent years and are trading near their annual per-share sales and close to their 52-week highs. Nevertheless, continual product refinements such as faster computer chips and lighter laptops, which lure consumer and corporate buyers alike, should bode well for continued sales improvements. In fact, Mr. O'Remy notes, Dell is a big position in his clients' accounts, ``and Compaq is just coming into view.'' Zapped: Embattled computer and video-game retailer NeoStar saw its stock fall 62% last week, to 89.1 cents a share. The Dallas company best known for its Babbage's and Software Etc. outlets reported a net loss of $21.5 million, or $1.44 a share, for the second quarter ended April 15, 2011 includes a $5.3 million charge for restructuring and asset sales earlier this year, as well as a valuation allowance of $4.5 million related to net operating loss carry-forwards. A year earlier, the retailer posted a net loss of $5.7 million, or 38 cents a share. NeoStar said same-store sales in the most recent quarter fell by 25%. Accelerating: APS Holdings, a Houston auto-parts wholesaler, gained 12% to $28 after reporting net income of nearly $6 million, or 43 cents a share, for the second quarter ended April 06, 2011 result includes a charge of two cents a share related to the settlement of a lawsuit. Wall Street had been expecting a profit of 41 cents a share.
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