Stock-market bargain hunters are a little like baseball scouts, trying to find talent that other teams have overlooked.
A scout might find a pitcher who is wild (walks a lot of batters) but has a thunderbolt of a fastball. An investor might find a stock with a low price relative to the company’s sales per share.
In each case, there’s a flaw. But the scout—or investor—hopes that the flaw can be fixed, while the good points will remain.
The price/sales ratio is good at pointing to turnaround candidates. Stocks don’t get cheap without a reason. When a stock has a low price/sales ratio, often the profits are puny compared to sales. You have to hope the company can become more efficient and improve its profitability.
The average stock these days trades for about 1.9 times sales, compared to a historical norm of about 1.5. Today I recommend four companies that trade for well under 1.0 times sales.
For years, Foot Locker
Perhaps that’s why Food Locker shares go for a price/sales ratio of only 0.28, compared to a ten-year median of 0.82.
But Foot Locker (which retails athletic shoes and clothing) still has a lot going for it. Profits have grown about 11% a year the past five years. Return on invested capital has been in my preferred zone (above 10%) in ten of the past 11 years.
CVS Health (CVS) is one of the two large drug stock chains that dominate the U.S. market. (The other is Walgreens Boot Alliance)
CVS, like most retailers, operates with slender profit margins. Its net margin (after taxes) was between 3% and 4% from 2007 through 2015. Since then it’s been between 2% and 3%.
I think that the company’s “Minute Clinics,” where customers can see a nurse, is a good innovation, and may be a traffic builder. The net margin poked back above 3% in the first quarter of this year. The stock goes for 0.4 times sales.
The company has shown a profit 11 years in a row (every year since the Great Recession), and has increased its earnings by better than 15% per year in the past decade.
Wall Street shrugs. Only three analysts cover it, and they all rate it a tepid “hold.” But if I’m right about this stock, it’s a good holding for people with a time horizon of two years or more.
Right now, lots of homebuilding stocks sell for a low multiple of sales. My favorite is D.R. Horton (DHI), which is the largest U.S. homebuilder and sells houses at a variety of price points.
Horton’s median price-to-sales ratio over the past decade has been 1.09. It current trades at a multiple of 0.88. Everyone is worried that high interest rates will cripple home sales. And it’s true that the Federal Reserve is raising rates aggressively.
But as I see it, rates are still well below where they were in the last great housing boom, around 2005-2006.
Starting in 1998, I’ve written 19 columns about stocks with low price/sales ratios. Today’s column is the 20th. Unlikely as it seems, the average one-year gain on my selections has been 30.1%%, compared to 9.4% for the Standard & Poor’s 500 Index.
I wouldn’t expect to produce 30% returns on a consistent basis. The good performance is due in substantial part to returns of 177%, 99% and 69% from 2000 through mid-2003. Value investing was having a heyday at the time. Of the 19 columns, 16 have been profitable and 11 have beaten the index.
My choices from a year ago were mostly duds. They lost 19.2% from July 19, 2021 through July 13, 2022, while the S&P 500 lost 9.4% (Both figures include dividends.) Netgear
Bear in mind that my column results are hypothetical: They don’t reflect actual trades, trading costs or taxes. These results shouldn’t be confused with the performance of portfolios I manage for clients. Also, past performance doesn’t predict future results.
Disclosure: I own D.R. Horton personally and for most of my clients.