We hunt for bargains, using Ken Fisher's price-to-sales ratio.
Last week, as part of my series of articles on the great investors, I took a look at the career of Ken Fisher. One of Fisher's preferred measures of value is the price-to-sales ratio (PSR), so today I've used the PSR to trawl the UK market and see what bargains I can find.
The price-to-sales ratio (PSR)
The problem with measures such as the price/earnings ratio (P/E) is that they only work if the company is actually making a profit. But there are many companies on the market that are not making a profit, but which still have some value due to expected future earnings, and we need a yardstick with which to measure these too.
In theory, we can attempt to forecast their expected free cash flows far into the future, discount this back to a current value using an appropriate discount rate, and derive a value that way. You might do this for a few companies, but it's not really a feasible method for sifting through the entire market.
But if these companies are at least at the stage of selling their wares, we can see how their revenues compare to their market values, and form a ranking on that basis. This is the PSR.
Problems with the PSR
The relationship between sales and profits varies hugely from industry to industry. Some high-volume retailers will accept a small margin to keep stock moving through quickly, whereas some high-tech businesses need to make chunky profits on each unit sold, while selling less product.
Comparing these companies using the PSR is not particularly meaningful. The PSR is more useful, therefore, when comparing companies within the same industry.
Another problem is that we are only comparing sales with the market capitalisation, i.e. the market value of the equity held by the shareholders. Some companies choose to fund their businesses entirely using equity, while others have substantial borrowings and less equity. A straight comparison between the two is not so easy.
For that reason, I have used a variant of the PSR that adjusts for the net debt of the company: Adding the market capitalisation and debt gives an 'enterprise value' (EV), and comparing this to the sales -- an EV/sales ratio (ESR) -- allows us to account for these differences in capital structure.
What did I find?
I have to admit that the PSR and ESR are not measures that I've ever paid any attention to in the past, so I was curious as to what they might reveal.
I've applied the ratio to some sectors that have a reasonable number of constituents, and that are not dominated by one or two giants, so that a meaningful intra-sector comparison can be made. I've also restricted the search to companies with a market capitalisation of over £10m, and have discarded any companies whose data looks obviously wrong following a few seconds of checking.
General retailers
The total ESR for the 42 general retailers meeting my criteria was 0.5, with 20 companies falling below this level. French Connection (LSE: FCCN) and Vertu Motors (LSE: VTU) were the cheapest, on ESRs of 0.06 each, with H.R.Owen (LSE: FCCN), DSG International (LSE: FCCN), JJB Sports (LSE: FCCN), Moss Bros (LSE: FCCN), and Clinton Cards (LSE: FCCN) all following closely behind.
The 10 cheapest general retailers, by ESR:
| Company | Market cap (£m) | Price (p) | EV to sales |
|---|
| French Cnctn. (LSE: FCCN) | 52.3 | 56.8 | 0.06 |
| Vertu Motors (LSE: VTU) | 39.1 | 41.0 | 0.06 |
| H.R.Owen (LSE: HRO) | 16.5 | 70.5 | 0.11 |
| DSG Intl (LSE: DSGI) | 494.9 | 23.5 | 0.11 |
| JJB Sports (LSE: JJB) | 72.7 | 30.3 | 0.12 |
| Moss Bros. (LSE: MOSB) | 17.9 | 19.5 | 0.13 |
| Clinton Cards (LSE: CC.) | 62.1 | 28.0 | 0.15 |
| Jacques Vert (LSE: JQV) | 13.5 | 7.4 | 0.15 |
| Blacks Leis. (LSE: BSLA) | 24.5 | 57.5 | 0.15 |
| Pendragon (LSE: PDG) | 205.5 | 31.0 | 0.15 |
Support services
The 99 companies on this list had a combined ESR of 0.77, with cheapest, Interior Services Group (LSE: ISG) scoring just 0.01. As David Holding recently pointed out, there may be good reasons why ISG is so lowly rated.
The 10 cheapest support services companies, by ESR:
Construction and materials
The 45 companies here had a combined ESR of 0.52, with Renew Holdings (LSE: RNWH) showing a negative 0.02. This is because, instead of having debts, the company has a net cash position that is worth more than the value of its shares -- worth digging more deeply into that one, I think. And what would you know, that man Holding has looked at this company recently as well.
The 10 cheapest construction and materials companies, by ESR:
But it's not that simple
As I've said regarding previous data filters, this is just a starting point. We cannot assume that all the data is correct, and we have to look at the reasons why these companies are 'cheap' and decide if they have been unfairly shunned by the Mr Market.
And as this search was within specific sectors, it is also worth remembering that even within sectors there can be huge differences between companies, so we may not be comparing apples with apples.
Happy fishing!
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