Tuesday, June 16, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (June 16, 1998) -- Yesterday, I suffered a brain freeze, so let me make a correction most of you probably made mentally anyway when you read my column.

In describing a stock with a Price/Sales Ratio of less than one, I mistakenly wrote that the investor is paying less than a dollar per share for each dollar of earnings per share. What I should have written, of course, is that the investor is paying less than a dollar per share for each dollar of company revenues (or sales) per share. My mistaken description is, of course, the Price/Earnings Ratio.

Both ratios are used to place a "value" on an individual stock, but the reason Jim O'Shaughnessy favors the Price/Sales Ratio is that it's more objective (and more effective historically). The price of the stock is straight-forward. A stock costs what it costs at any given time. Period.

The difference in the two ratios comes in the other factor, earnings versus revenues. With the complicated accounting regulations in place, a company's earnings can be manipulated (completely above-board, mind you) to where the Earnings Per Share numbers cease to mean much. Just how many quarters in a row can a company report "special charges" before they're no longer "special?"

With the Price/Sales comparison, though, the sales (or revenues) numbers are much more objective. Sure, there's still some sliding room in how companies are allowed to report revenue, but it's a much more objective number than a company's reported earnings.

The Price/Sales Ratio, therefore, gives a little more objective view of the company's value relative to its current business success. And as Jim's research shows, it's the most reliable ratio he could identify for value.

So, mea culpa on yesterday's slip, and I hope today's explanation makes it somewhat clearer why as a value ratio, Price/Sales proves to be a more accurate indication of a stock's "value" than does the more widely used Price/Earnings Ratio.

For those of you who have been putting off ordering a copy of my book, The Unemotional Investor, in hopes of getting an autographed copy, here's your opportunity. Thursday night at 9:00 (Eastern), I'll be doing a combination chat and online book signing in The Motley Fool's America Online auditorium. Stop by and join the discussion and we'll fix you up with an autographed copy, if you like. If you can't make the chat but still want an autographed copy of the book, we'll have a special order form available beginning sometime tomorrow. Please check back here or in my Foolish Four column for a link to that special form tomorrow. Fool on!

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]