VALUE INVESTING
Price to Sales: Use With Care

By Stephen Bland (TMFPyad)
August 10, 2001

Following last week's article, in which I looked at three common value ratios as applied to the FTSE 350 index, it was suggested by one of the regulars on the value board that it might be interesting to try the same thing with the Price/Sales ratio. This particular ratio, used by many value investors, is not one to which I personally attach a lot of importance. As far as I can recall, I don't think I have ever used it when searching for value plays for my own investments.

However each value investor has their own pet series of ratios and other factors they consider when sizing up a share, and some may find a low P/S listing useful.

Here are the ten lowest P/S ratios in the FTSE 350:

Company                      P/S ratio

Iceland (LSE: ICE)            0.10
Somerfield (LSE: SOF)         0.11
Inchcape (LSE: INCH)          0.15
Carillion (LSE: CLLN)         0.17
Aegis (LSE: AGS)              0.20
Corus (LSE: CS.)              0.20
Computacenter (LSE: CCC)      0.22
Coats (LSE: CO.)              0.23
Arcadia (LSE: AG.)            0.24
Enodis (LSE: ENO)             0.25

The figures are from the last annual accounts.

As with last week's article, I make no comment on the quality of these companies because this is a purely mechanical selection.

Many on the list are involved in high volume retail or distribution type businesses. This is as expected and such companies will generally figure strongly in low P/S lists. That is one of the reasons that I don't pay too much attention to this ratio; it will tend to produce a load of supermarkets and the like simply because these tend to trade at a low P/S.

My approach is always a whole market view -- "top down" not "bottom up". I don't really care too much about what business my shares are in, that's too macro for me, only that they show up in my value tests. They are all just a load of numbers which talk to me and if I like what they say I'm interested, but not interested normally in the details of their business. I rarely go looking in particular sectors, though that can be a very valid approach. It's just not my style usually, though I do use it sometimes especially for non-deep-value side bets. Typically a bottom up player will head for bombed out sectors, then analyse the shares there to try and find something that has been creamed unfairly simply by being in the sector rather than because its fundamentals are poor.

The P/S ratio therefore may be more useful when comparing the merits of shares in the retail or distributive sectors with each other, rather than against the whole market. Similarly, you could use it for any particular sector where the shares are in fairly closely related businesses to give you an idea of which ones are lower rated by the market against their peers on this ratio.

Even then though, on its own P/S is probably pretty limited and I would suggest it needs to be used with several other value ratios to judge a share. What it will reveal if you applied it to, say, the supermarkets is that the more efficient ones like sector star Tesco (LSE: TSCO) will probably have a higher P/S than the less profitable constituents of this sector. That is the anticipated outcome. As a value player, though, you would be looking for the unanticipated outcome, that is a share which has in your opinion an unreasonably low P/S undeserved as demonstrated by the other usual indicators like P/E and whatever else you choose to use as measures of the share's value. Used in this way, particularly with this sort of sector, P/S has merit.

Taking my three tables last week, which covered low P/E, high yield and low price to book, and comparing with the low P/S list here, there are no shares that appear in all four tables, nor even any that appeared in all three last week. However, Coats (LSE: CO.) appears in this week's low P/S list and also in the low P/E and high yield tables, the only one to make an appearance in any three out of the four tables. As I say above though on quality, I make no comment on the merit or otherwise of this share: it is not a company at which I have looked, all this being completely mechanical.

Nearly forgot to mention; I own shares in Inchcape (LSE: INCH).