PSR: One simple trick for picking big winners
If you're researching a company to invest in, earnings are a vital consideration. There are few things as important to an equity investor as the net profits of a business - and where they are going. But there is another measure that is equally important: Sales growth. And that's what the price-to-sales ratio comes in. Read on to uncover this one simple trick for picking big winners…
Anyone who has run a business knows that you can increase profits for a while simply by cutting costs, Alexander Green in Investment U
But there are limits. After a while, you just can't cut costs further without eroding the underlying business.
So sustained bottom-line growth demands robust top-line growth.
Great sales growth generally precedes outstanding profit growth. Of course, you can overpay for sales just like you can overpay for earnings.
Understanding price to sales
In his 1984 book Super Stocks
, money manager and Forbes
columnist Ken Fisher said his primary stock-picking tool was the price-to-sales ratio (PSR).
The price-to-sales ratio is the share price divided by revenue to share.
He argued that stocks that sell for 1.5 times sales or less are often good values. And those that sell for 0.75 times sales or less can be incredible bargains.
If you're searching for stocks that sell even cheaper than this, be prepared to look at companies that are completely out of favour.
How has this approach worked out for Fisher? Not bad. His $42 billion registered investment advisory is one of the world's biggest. And his $2.3 billion personal net worth puts him in good company: The Forbes 400.
Clearly, Fisher has gathered a lot of assets using his price-to-sales approach. It's an approach worth emulating.