VALUE: After Hours (S07 E44): Why Price-to-Sales Matters More Than Earnings at the Cycle Extremes

During their recent episode, Taylor, Carlisle, and Value Stock Geek discussed Why Price-to-Sales Matters More Than Earnings at the Cycle Extremes. Here’s an excerpt from the episode:

Value Stock Geek: No. So, one of the big things I look at is trending in price to sales. So, what price to sales ratio does this normally trade at and what does it trade at now? That’s a key metric I look at. And so, that keeps me from saying like, “I need to get super deep value,” where some companies will never trade at a 10 PE. Copart is a good example of a company that may not get that low. But if you look at trending in price to sales, you can identify these inflection points when they might be a little bit cheap.

So, yeah, usually I rank everything by discount to its typical price to sales ratio, and I rank all the companies by that criteria, and then I’ll look at absolutely earnings yield. So, I’ll say like, is the earnings yield at least maybe in excess of the current 10-year treasury yield. Basically, today it is the enterprise multiple below 20, and is the price to sales, and then rank that by the price to sales discount to where it normally trades.

Jake: Are you using price to sales, because it’s such a clean metric? There’s not a lot of counting shenanigans between revenue and revenue?

Value Stock Geek: Yeah. I’ve noticed for a lot of these companies, price to sales– You’re right. Sales is more stable. But what you can really pick up, there are cycles in margins. So, you look at margins and price to sales for a lot of companies, and often it looks like a wave, and you can identify points where, okay, this is probably just a cyclical phenomenon and it’s trading at a super low-price sales multiple, because margins are temporarily depressed, as opposed to–

I think that’s better than what the traditional magic formula does where it’s only looking at trailing 12-month ROIC. Because I think what that does is it tends to identify companies at cyclical peaks which is why as Toby’s research has proven that that tends to underperform pure value. I think it’s because it identifies a lot of those companies that are trading at cyclical peaks.

I remember looking through magic formula screens, and it would often things would pop up like that. Like Cal-Maine 2015, the egg producer. You know that was popping up on the magic formula screen. I think back then there was another bird flow, and prices were high. Well, what happens? Markets work. Egg producers will create more eggs, and prices will eventually come down. And then, it identifies a lot of fads like Fitbit. That was another one that was in there.

Jake: Right. Yeah, it is prone for hula hoop behavior.

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