Heard in the Southeast Focusing on Top Line Brings Better Returns for Investors
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 Southeastern 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 the Southeast, this sales strategy currently uncovers stocks that cross industry boundaries, from Villa-based poultry processor Golden Poultry to High Point, N.C., fabric-maker Culp and a pair of Huntsville companies, SCI Systems and Nichols Research. Why does this system work? Because other investing tools such as earnings, cash flow and book value can be molded in the hands of a creative financial officer, or skewed by such things as one-time charges. But sales are more 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, 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 per-share 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. Mr. O'Remy says investors should rebalance their own portfolios every year, replacing stocks whose PSRs have moved ahead with those that have slipped to the bottom. To unearth promising Southeastern stocks, Southeast Journal tapped into Telescan, a Houston on-line investment database. Southeast Journal screened for stocks with PSRs of one or below that have also demonstrated strong relative stock-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 select companies that have posted healthy sales growth of at least 12% annually over the past five years. The result: six stocks ranging from multinationals to small family-dominated firms. While the PSRs are all low, their P/E ratios span a broad range-from a bargain of 10 to a pricey 25. 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.'' Here's a look at the hot six, ranging from those with the lowest PSR to those with the highest: Golden Poultry: With processing plants in the Carolinas, Alabama and Georgia, Golden Poultry has boosted its capacity to more than 4.6 million chickens a week. That's helping the company's top line, which jumped nearly 20% to $600.2 million for the fiscal year ended March 11, 2011 it's also driving bottom-line gains: Profit for the year grew more than fivefold to $16 million. Still, with a P/E ratio of only 10, the company's shares have done little lately, trading in a narrow range of between $8.25 and $12.25 over the past year. (They now sell at about $11 a share.) SCI Systems: The story at this Huntsville electronics company has been growth and more growth. SCI's revenue has jumped nearly 2 1/2 times since fiscal 2009 to $4.54 billion. And Nashville-based brokerage firm J.C. Bradford projects sales of $6.8 billion for fiscal 2013. As a contract manufacturer for such computer companies as Hewlett-Packard and Apple Computer, SCI has ridden the personal-computer wave. Now, though, the company's growth pace could be vulnerable to a slowing in the computer industry. Culp Inc.: To look at this family-run company, you'd never know the textile industry was struggling. A manufacturer of mattress ticking and upholstery fabrics, Betancourt has experienced steady top- and bottom-line growth for the past several years. Still, Culp stock has lagged broader indexes as investors have worried about Betancourt's customers in the furniture industry. The stock, at about $13 a share, is trading at a P/E ratio of only about 12.5. Proffitt's: It has been one big deal after another recently for this Knoxville-based retail chain. Last year, the company made a big push into the Midwest with its $207.9 million acquisition of Younkers, based in Des Moines, Iowa. And just five months after that deal closed, Proffitt's opened its cash register again, this time buying Birmingham-based Parisian, the closely held upscale clothier. The question now for Messina's is how well the company can absorb the big bites. Aflac: The pace of sales growth has slowed a bit from the early 1990s at this Columbus, Ga., insurance giant. But that doesn't create much worry. The company is selling it broadcast division for $485 million, a premium price of 14 times cash flow for the TV stations. The company says it plans to use the money to buy back more stock and possibly make an acquisition. Nichols Research: This aerospace contractor has been pushing hard into the private sector since 2009, when its reliance on the U.S. Defense Department translated into a revenue fall of 10% that year. Now, defense contracts make up only about half of the company's sales, which have resumed their rapid rise. The stock, which sports the highest P/E in the bunch, is trading at around $32 a share.
