If stock market investors have a favorite variable to focus on, it likely is earnings. They study the P/E (price-to-earnings) ratio, look closely at earnings growth rates and hang on every word that is uttered on earnings calls.
However, not every savvy investor is so enamored by earnings. Ken Fisher, the best selling author, money manager and Forbes columnist, thinks sales are more revealing than earnings. Fisher found that earnings are far more volatile than sales because everyday decisions, such as replacing equipment or upping research & development expenses, can cause earnings to fall, while such fluctuations may reveal nothing about the strength of a company's underlying business. And if a company has a loss, well, there goes the P/E ratio as an investment analysis tool.
While Fisher does look at earnings per share, he focuses on the price-to-sales ratio, which he wants to see below 1.5 and gets really excited about if it falls below 0.75 for non-smokestack (non-cyclical) companies. For smokestack (cyclical) companies, the P/S should be between 0.40 and 0.80.
As 2015 ends, I want to acknowledge my Fisher-based strategy as a star long-run performer. This strategy, which I based on Fisher's classic investment text, Super Stocks, from 1984, has generated an annualized return of 13.1% since its inception in 2003, as compared with the S&P 500's annualized return of 6.6% for the same time period, the best of the dozen or so strategies I follow. Fisher obviously knows of what he speaks.
One of the companies my Fisher-based strategy pinpoints as worth investing in is Winnebago Industries (WGO), the iconic recreation vehicle manufacturer known particularly for its motorhomes. A cyclical company, Winnebago's P/S of 0.61 is almost exactly in the middle of the desired range of 0.40 and 0.80. The company is also traveling smoothly, with positive free cash flow per share, strong EPS growth and a solid three-year average net profit margin of 5.49%.
Looking at non-cyclical companies, TRW Automotive Holdings (TRW) is a major supplier to the automotive industry whose products include airbags, seat belts, engine valves and electronic components. TRW has a very strong P/S of 0.64 (remember that a P/S below 0.75 is very desirable under the strategy). Free cash flow is positive, EPS is growing rapidly and the company's three-year average net profit margin is 6.27%.