While Smith focuses on a company’s price-to-book ratio, James O’Shaughnessy of O’Shaughnessy Capital Management, Greenwich, Connecticut, says the price-to-sales ratio is the best value indicator. “We have checked data going back to the 1950s,” he says, “and companies with low price-to-sales ratios turn out to be the best performers in the future.”
The trouble, says O’Shaughnessy, is that some stocks sell at a low price-to-sales ratio because the company’s prospects are dim. Thus, investors need a way to separate undervalued companies with good prospects from those that are about to be buried. “The best combination of indicators is a low price-to-sales ratio
with 52-week price momentum,” he says.
Currently, for example, the average stock has a price-to-sales ratio of 3:1, so O’Shaughnessy starts by screening for stocks with a ratio under 1.5:1. “From that list of stocks we pick the ones with the greatest one-year price appreciation,” he says. “Following such a strategy, you’d have earned 19% per year for the past 45 years vs. 13% for the S&P 500. A $10,000 investment would have grown to more than $30 million.” One site that offers customized stock screening is www.schwab.com (see the sidebar, “Set Your Sites for Better Stock Picking”).
Other experts find still other numbers critical to making good investment decisions. Bob Olstein, whose Olstein Financial Alert Fund has gained nearly 28% a year for the past three years, looks at the ratio of total assets to shareholders’ equity. “If that ratio is over 2.5:1,” he says, “the company may be a risky investment because of excess debt.” Similarly, Olstein is wary of companies where accounts receivable and inventories are rising faster than sales, because that means a company is producing more goods than customers want.
Most important, says Olstein, is whether a company is generating excess cash flow each year. That is, he likes to see a business that brings in more cash than goes out. “The cash can be used to pay down debt or to build up cash reserves. Ideally, we like to see enough cash come in to permit the company to pay off all of its debt within six years.”
Among Olstein’s favorites is General Motors (NYSE: GM), which generates $3 billion worth of free cash flow each year. “The stock doubled in the last four years and I think it’s still 50% undervalued,” he says. J.C. Penney (NYSE: JCP) is another favorite of his, with a solid 6% dividend yield.
(The average blue chip stock yields around 1%.) All of this information, says Olstein, is available in the quarterly and annual reports that every company must file with the SEC-yet one more source of online data to help you make investment decisions just like the big leaguers do.
Perhaps the best approach is a balanced one, a do-it-yourself portfolio tempered by professional consultation as needed. In this respect, Bailey may have the best of both worlds. He has both a conservative retirement portfolio, for which he relies upon financial planner Hatcher, and a smaller speculative portfolio, for which