The Motley Fool: No earnings? Use sales to figure PSR
Investors frequently evaluate companies based on earnings. But what if there are no earnings, such as with young companies or firms in temporarily tough times? Then focus on sales (often referred to as revenues), via the price-to-sales ratio, or PSR.
The PSR takes the market capitalization of a company and divides it by the past 12 months’ sales. The market cap is the current value that the market is giving the company, arrived at by multiplying the current share price by the number of shares outstanding.
Imagine Iditarod Express (ticker: MUSHH), has 10 million shares outstanding, priced at $10 a share, then its market capitalization is $100 million. If it had $200 million in sales over the last four quarters, its PSR would be 0.50 ($100 million divided by $200 million equals 0.50).
Assume that Iditarod Express lost money in the past year but has a PSR of 0.50, while its peers have PSRs of 2.0 or higher. If it can turn itself around and start making money again, it’s likely to have a substantial upside if it can match competitors’ profit margins. (Then again, perhaps its price is low for some good reasons.) There are some years when many companies in an industry are not profitable. This doesn’t mean they’re all worthless and there’s no way to compare them. Just use the PSR instead of the price-to-earnings ratio. Measure how much you are paying for a dollar of sales instead of a dollar of earnings.
Compare the PSR with sales growth, too. A high PSR isn’t necessarily bad if sales are growing rapidly.
Despite its usefulness, though, the PSR should never be the only number you crunch. It can give you some context for a company’s value relative to its industry peers, but revenues must be transformed into rising earnings to make shareholders happy. How much a company earns from its sales will eventually influence the value of the business and the stock.
Ask the Fool
Q: What does “liquidity” mean in the financial world? – L.P., Lake City, Fla.
A: It often refers to a company’s cash and assets that can be quickly converted into cash (such as money market funds and investments in stocks and bonds), minus its short-term debt. Companies with high liquidity can be less risky, but they might also grow more slowly, as assets that could be put to work growing the business are instead kept readily accessible.
Liquidity also refers to the stock market’s ability to handle a large volume of trading without big price swings. Major investors such as mutual fund managers care about this because if they want to buy a million shares of something, they don’t want their purchases to drive up the stock price sharply.
My dumbest investment
In early 2000, I watched Celera Genomics’ stock rise to the heavens. Figuring I’d missed out on Celera, I thought I might be able to find a smaller, lesser-known genomics stock that might still do well. I found a worthy candidate in Hyseq and bought 1,000 shares at around $17 apiece. Shortly thereafter, I sold my shares at $99 and declared myself a genius. I only needed to quintuple my money two more times to be a millionaire, and in those giddy days, anything seemed possible. I figured that stem cell companies might be the next big thing, so I invested in one. Well, it soon plunged, along with much of the market, and I lost most of my ludicrous Hyseq gains. In retrospect, I knew little about either company, and what I was doing certainly could not be called investing. Charitably, one might term it speculating, but it was really more like gambling. Today I invest in broad-based mutual funds with strong Morningstar ratings. – S.C., Hummelstown, Pa.
The Fool responds: Amen.