Investors who bought shares of IBM in the 1950s, Toyota in the 1960s, Wal-Mart in 1970, Microsoft in 1986, Cisco in 1990, or Google in 2004 are hailed as visionaries . . . or the luckiest people on the planet. They are universally envied, because most of them today are more than comfortably well off.
Where do you get the vision, or the luck, that leads you to that blockbuster payday? How do you find the under-valued stocks of today that will become the superstars of tomorrow?
You do your research. The standard rule of thumb is to look for bargain-basement-priced stocks of companies with strong fundamentals: a great and unique product or service, a great potential market, great management team, great predictability, and a track record of strong growth year after year.
But how do you know if a stock is truly under-valued? Well, most investors look at the company’s P/E, its price-to-earnings ratio, to find inexpensive but high-quality stocks. They simply divide today’s share price by last year’s earnings per share.
If Company X earned $2.53 per share over the last 12 months and the current share price is $28.47, you would divide $28.47 by $2.53 to get a P/E of 11.3.
Then, you would compare that P/E to the S&P 500 as well as to Company X’s industry average, the company’s historical average, and the P/E of Company X’s competitors to determine if the stock is inexpensive, over-priced, or somewhere in between.
If the S&P500’s P/E, for example, was 14.9, then Company X’s P/E of 11.3 would tell you that its shares are under-priced in relation to other S&P 500 stock. If Company X’s historic P/E average is 8.4, then its shares are currently over-priced.
Now that you understand how most investors use P/E, forgot about it, because there’s a much better way to find the inexpensive high-value stock that can give you blockbuster earnings.
The price-to-sales ratio (P/S) can point you to potentially blockbuster stocks that are priced below the industry average, including growth stocks that have suffered a temporary setback.
To get a company’s P/S, you simply multiply the company’s number of shares by its share price. Then you divide that number by the company’s total sales over the past 12 months. A lower ratio means the stock is under-valued. Symantec, for example, currently has a P/S of 1.8 compared to its competitors’ P/S of 3.8. Looks like Symantec stock is a bargain today.
I know what you’re thinking: easier said than done. Yes, stock investment does require a bit of elbow grease. You’ve got some research to do.
Where do you find a company’s number of shares? Many websites will sell you that information, or you could use a great free resource: YAHOO! Finance [link to http://finance.yahoo.com/].
You can get a company’s share price by opening the financial section of any newspaper, but, again, an easy and free resource for this information is YAHOO! Finance. This website also gives you most of the information you need to understand a company’s fundamentals, as well as current news about the company.
Where do you find a company’s total sales over the past 12 months? YAHOO! Finance.
It’s also helpful to compare a company’s P/S to its industry’s average, which you can also find on YAHOO! Finance.
A Blockbuster Payday
Can using P/S rather than P/E really give you a blockbuster payday?
A test conducted by a senior analyst recently found that, over a ten year period, companies whose P/S was below the industry average in 2001 significantly outperformed the S&P 500 every single year of that decade. How significantly?
A $1,000 investment made in 2001 would have earned $286,535 over ten years despite the 2008 stock market crash and debilitating global recession.
As I explain in my article, “Like Options? You’ll Love Investing in LEAPS” [link to article], if you had purchased LEAPS contracts instead of buying those stocks, your payday at the end of those ten years would probably have been in excess of $1,000,000.
With P/S in your investment toolkit, you could become the next visionary investor . . . and the luckiest person on the planet.
For more information about finding potentially blockbuster stocks, take a look at my article, “How to Find the Superstar Stocks of Tomorrow.”