Investment in stocks after analyzing the valuation metrics is considered one of the best practices. When considering the valuation metrics, the price-to-earnings ratio has always been the obvious choice. This is because calculations based on earnings are easy and come in handy. However, the price-to-sales ratio is convenient for determining the value of stocks that are incurring losses or in an early development cycle, generating meager or no profit.
What’s the Price-to-Sales Ratio?
While a loss-making company with a negative price-to-earnings ratio falls out of investor favor, its price-to-sales can indicate the hidden strength of the business. This underrated ratio is also used to identify a recovery situation or ensure a company’s growth is not overvalued.
A stock’s price-to-sales ratio reflects how much investors pay for each dollar of revenue generated by a company.
If the price-to-sales ratio is 1, investors are paying $1 for every $1 of revenues generated by the company. A stock with a price-to-sales below 1 is a good bargain as investors need to pay less than a dollar for a dollar’s worth.
Thus, a stock with a lower price-to-sales ratio is a more suitable investment than a stock with a high price-to-sales ratio.
The price-to-sales ratio is often preferred over price-to-earnings, as companies can manipulate their earnings using various accounting measures. However, sales are harder to manipulate and are relatively reliable.
However, one should keep in mind that a company with a high debt and a low price-to-sales ratio is not an ideal choice. The high debt level will have to be paid off at some point, leading to further share issuance, a rise in market cap, and, ultimately, a higher price-to-sales ratio.
In any case, the price-to-sales ratio used in isolation cannot do the trick. One should analyze other ratios like Price/Earnings, Price/Book and Debt/Equity before arriving at any investment decision.
KB Home KBH, Medallion Financial Corp. MFIN, ePlus PLUS, Charles River Associates CRAI and PagSeguro Digital PAGS are some companies with a low price-to-sales ratio and the potential to offer higher returns.
Price to Sales less than the Median Price to Sales for its Industry: The lower the price-to-sales ratio, the better.
Price to Earnings using F(1) estimate less than the Median Price to Earnings for its Industry: The lower, the better.
Price to Book (common Equity) less than the Median Price to Book for its Industry: This is another parameter to ensure the value feature of a stock.
Debt to Equity (Most Recent) less than the Median Debt to Equity for its Industry: A company with less debt should have a stable price-to-sales ratio.
Current Price greater than or equal to $5: The stocks must be trading at a minimum of $5 or higher.
Zacks Rank less than or equal to #2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform, irrespective of the market environment.
Value Score less than or equal to B: Our research shows that stocks with a Value Score of A or B, when combined with a Zacks Rank #1 or 2, offer the best opportunities in the value investing space.
Here are five of the 21 stocks that qualified for the screening:
Based in Los Angeles, CA, KB Home is a well-known homebuilder in the United States and one of the largest in the state. The company’s homebuilding operations include building and designing homes that cater to first-time, move-up and active adult homebuyers on acquired or developed lands. KBH also builds attached and detached single-family homes, townhomes and condominiums.
KB Home’s growth is driven by the Returns-Focused Growth Plan, which includes the execution of its core business strategy, improving asset efficiency and monetizing significant deferred tax assets. Its long-term growth is attributable to the increase in backlog and its ability to match housing starts to net orders. Also, the company’s robust land acquisition strategies assist it in reducing debt, and boosting the gross margin and returns. The KBH stock has a Value Score of A and a Zacks Rank #2. It has an expected long-term earnings growth rate of 7.1%.
Medallion Financial operates as a finance company in the United States. It originates and services a growing portfolio of consumer loans and mezzanine loans in various industries. Key industries served include recreation (towable RVs and marine) and home improvement (replacement roofs, swimming pools and windows).
The company has been witnessing continued growth in its consumer lending businesses. MFIN has a Value Score of A and currently sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Herndon, VA-based ePlus is a provider of information technology (IT) solutions that enable organizations to optimize their IT environment and supply-chain processes. PLUS operates in the United States and internationally. ePlus serves commercial entities, state and local governments, government contractors, and educational institutions.
PLUS is benefiting from the solid demand for its security, modern data center and networking solutions. The company is focused on driving sustainable, long-term growth by expanding its capabilities, investing in talent and capturing share in targeted high-growth market segments. It currently has a Value Score of B and flaunts a Zacks Rank #1.
Charles River is one of the leading global consulting firms. This Boston, MA-based company is engaged in providing economic, financial and management consulting services. Its professional team has helped maintain a solid reputation for premium consulting services. Charles River has a widely diversified business, with service offerings across areas of functional expertise, client base and geographical regions.
The solid international network allows Charles River to work with the world’s leading professionals on multiple issues. We believe that the company’s international operations help expand its geographic footprint and contribute to the top line. CRAI currently has a Value Score of B and a Zacks Rank #2. It has an expected long-term earnings growth rate of 13%.
São Paulo, Brazil-based PagSeguro Digital provides financial technology solutions and services for micro-merchants, and small and medium-sized businesses in Brazil and internationally. The company offers multiple digital payment solutions, in-person payments via point-of-sales devices and prepaid card services. PagSeguro Digital has been diversifying its payments business and 2022 marked the consolidation of its HUBs initiative to extend its best-in-class services to small and mid-sized clients.
PagSeguro Digital’s disciplined capital allocation has significantly aided operating and investing cash flow generation, positioning it to further explore the opportunities in Payments and Financial services in the Brazil territory in the coming years. The PAGS stock currently has a Value Score of A and a Zacks Rank #2. The company has an expected long-term earnings growth rate of 9.9%.
Charles River Associates (CRAI): Free Stock Analysis Report
This article originally appeared on Zacks
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