When most folks encounter a "glitch," they think, "Whoops, there's a problem." But Kenneth Fisher, the noted money manager, author, student of investing psychology and long-time Forbes columnist, loves glitches. He views them as opportunities, not problems.
In his book Super Stocks, Fisher found that companies often have a period of strong early growth and considerable popularity, which raises Wall Street's expectations to unrealistic levels. When the companies have a setback, investors, thinking they've been led astray, bail out and send the stock price down.
This overreaction by investors, which Fisher calls "glitches," creates buying opportunities. If the company has solid management, it will solve its problems and move forward and its stock price will rebound.
To identify when a good company is just going through a rough patch, a glitch, Fisher determined it was best to look at sales, and he focused on the price-to-sales ratio. The more popular price-to-earnings ratio loses some of its analytical power when profits plummet for reasons that can be remedied, and cannot be used at all if the company loses money. Fisher found that earnings fluctuate far more than sales, which made him an acolyte of the P/S ratio. Specifically, he found that sales of what he called "Super Companies" (those capable of growing their stock price three to 10 times in value in a period of three to five years) rarely decline significantly, though their profits sometimes do.
The P/S ratio Fisher looks for ranges between 0.4 and 0.8 for smokestack (cyclical) companies, and below 0.75 for non-smokestack (non-cyclical) companies. These represent good values. In addition to the P/S ratio, he also looked at the total debt-to-equity ratio, long-term earnings-per-share growth rate, which needs to be greater than 15%, positive free cash per share, and a three-year average net profit margin of 5% or greater.
In 2003, I computerized the strategies of great investment gurus, including Fisher. These strategies allow me to analyze stocks instantly according to the dictates of each investment philosophy. I can say from experience that Fisher's Super Stocks strategy works. Since its inception in July 2003, my 10-stock Fisher-based portfolio has gained 301%, or 13.7% annually, vs. the S&P 500's 87.7%, or 6% annually.
Here are two of my Fisher strategy's current favorites:
AGCO Corp. (AGCO) is an international farm-machinery company whose brands include Challenger, Fendt, GSI, Massey Ferguson and Valtra. Considered a cyclical company, AGCO's P/S ratio is 0.48, while its long-term EPS growth rate is 27.4%.
Mueller Industries (MLI) manufactures copper, brass, plastic and aluminum products used in plumbing, HVAC, refrigeration and other industries. A non-cyclical company, its P/S ratio is 0.74, and its long-term EPS growth rate is a strong 74%.