Whether it’s talk about earnings growth or earnings estimates or price/earnings ratios, stock market news is usually filled with discussions of corporate earnings. But in his latest for Seeking Alpha, Validea CEO John P. Reese says that good investing goes beyond looking at earnings-related metrics.
“Earnings don’t always tell the whole story,” Reese writes. “In fact, oftentimes other metrics can provide an even better gauge of how a company or the market is doing. The Price/Sales Investor strategy I track on Validea.com is a good example. The key variable it looks at is the price/sales ratio – PSR – which compares a company’s market capitalization to the amount of sales it has taken in over the past year.”
Reese examines this investment model, which is based on the approach of Kenneth Fisher, as well as his James O’Shaughnessy-inspired model, which also uses the PSR. “Fisher thought there was a major hole in the P/E ratio’s usefulness,” Reese says. “Part of the problem, he explained, is that earnings – even earnings of good companies – can fluctuate greatly from year to year. The decision to replace equipment or facilities in one year rather than in another, the use of money for new research that will help the company reap profits later on, and changes in accounting methods can all turn one quarter’s profits into the next quarter’s losses, without regard for what’s truly important in the long term – how well or poorly the company’s underlying business was performing. But while earnings can fluctuate, Fisher found that sales were far more stable, and a better gauge of a company’s strength and prospects.”
Reese looks in-depth at his Fisher- and O’Shaughnessy-inspired strategies, as well as a few stocks that currently get high marks from one or the other. Among them: Sanderson Farms, which has a PSR below 0.8.