3 Stocks With Small Price-to-Sales Ratios

Would you pay $100,000 for a business with yearly sales of $150,000? It sounds like a good deal, but of course, profit matters more than sales. The business might produce a $10,000 loss each year after expenses are deducted, or it might generate a $50,000 profit. For that reason, most stock investors prefer to discuss company valuations in terms of the price-to-earnings ratio, rather than the price-to-sales ratio.

In several long-term studies, however, the P/S ratio has proved a better predictor of stock returns. Perhaps that's because earnings are far more volatile than sales, and the P/E ratio can mislead when earnings are temporarily suppressed or inflated. Or, it might be related to research showing that profit margins tend to revert to industry averages over long time periods, as extraordinarily profitable companies attract new competition, and as companies with weak margins come under shareholder pressure to make improvements.

Among the large, American companies that make up the S&P 500 index, the median P/S ratio is 1.5. However, ratios vary sharply by industry, according to whether companies specialize in achieving high sales volume or large mark-ups, and according to investor popularity. For mass merchants, the median P/S ratio is 0.5. For software developers, it's 3.5. (more)

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