The Big Ticket Screen

by Rick Munarriz
(TMF Edible)

MIAMI, FL. (August 7, 1998) -- After some vintage Robert Sheard and a great two-part look at relative strength by David Forrest, you are stuck with me to close out the week. Robert will be back next week. Honest. I trust the only screens going through his mind right now are sunscreens. He's earned it, that's for sure. Anyway, like any good substitute I've taken kindly to the "Kick Me" sign on my back and will make this Friday session as light as possible.

A disclaimer early on is that I am not screen-intensive. Wait! Get back in your seats! By the same token, it's not as if I'm penning the last chapter of The Emotional Speculator, either. Rather than Swiss cheese my credibility any further let's take a look at what might be the most misleading screen of all, Low Price to Sales.

On the surface, this is one of the weakest screens. After all, a company is ultimately valued not by how much money comes in, but rather by how much of that it keeps. Price to Sales and its more popular half-sibling, Price to Earnings, are clearly not the same thing. Why? Margins. Companies that make the cut on this screen are typically low margin. Logic dictates it. If a company like Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, with 30% net margins, was trading at just one time sales, it would have a P/E of 3. Granted, if that were the case Bill Gates would be sulking in a cardboard box and I would be the guy backing up the truck. It just doesn't happen. But before you think that the bargain bin when it comes to market capitalization relative to trailing sales is a quality vacuum, let's look at the list. Try to find the recurring theme in many of these entities.

Low Price/Sales
Recoton Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RCOT)") else Response.Write("(Nasdaq: RCOT)") end if %>
Computer Sciences <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSC)") else Response.Write("(NYSE: CSC)") end if %>
Westpoint Stevens <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WPSN)") else Response.Write("(Nasdaq: WPSN)") end if %>
Lowe's Cos. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOW)") else Response.Write("(NYSE: LOW)") end if %>
Fingerhut Cos. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FHT)") else Response.Write("(NYSE: FHT)") end if %>
TJX Companies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TJX)") else Response.Write("(NYSE: TJX)") end if %>
Champion Enterprises <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHB)") else Response.Write("(NYSE: CHB)") end if %>
Pulte Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PHM)") else Response.Write("(NYSE: PHM)") end if %>
Office Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ODP)") else Response.Write("(NYSE: ODP)") end if %>
Centex Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CTX)") else Response.Write("(NYSE: CTX)") end if %>

That's right. Retail stocks. A lot of retail stocks. You can walk into half of these names and walk out with something. Hopefully you paid for that purchase. We don't want to have anyone arrested, it being Friday and all. Well, if you take a closer look at these retailers you will find that these aren't the terminally hip denim and "whatever those 90210 kids are wearing these days" suburbia mall shops. No, these are the big ticket, and in some cases discount, stores resting here. Why?

Volume. Rather than selling a few items at significant premiums, they go for petty markups and hope to make it up in sales. Let's break it down, fictionally. Tori Reading Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BABY)") else Response.Write("(Nasdaq: BABY)") end if %> sold two pairs of bell-bottom trousers for $50 each today. They cost the company $30 each. Total sale? $100. Meanwhile, Aaron Reading Discount Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DADA)") else Response.Write("(Nasdaq: DADA)") end if %> sold four pairs of those very trousers at $40. Total sale? $160. For early dismissal and a chance to Krazy Glue the keyhole of the teachers' lounge, which company made more money?

The answer? Neither. Both. Same difference. Tori took $60 worth of clothing and sold it for $100. Meanwhile, Aaron took $120 worth of hideous fashion and turned it into a $160 sale. They both netted a $40 profit. Even if the market were to value both companies evenly based on Price to Earnings, Aaron would have higher revenues, hence a lower Price to Sales ratio. Realistically though, Wall Street would probably reward a higher P/E to Tori just because investors are attracted to higher margins. It gives the company more leeway to negotiate pricing without giving up profitability, but more than that, the company has something extra special that people are willing to pay up for.

But let's emphasize the point that a company that makes up fiscal performance in quantity can still be a quality company. Try on Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %> for size. Or, better yet, pull up the income statements from each and every supermarket stock you can find. Net profit margins in the 1-2% range are a constant -- and it's not a bleak constant when boxes of Froot Loops keep getting rung up again and again.

So it is quite likely that this list will always be full of retailers (like TJX, Lowe's, Office Depot and Fingerhut) and other "boring" big ticket industries like home builders (Centex and Champion Enterprises), and even a company like Westpoint Stevens that will provide the soft home fashions that ultimately wind up in the Centex house and the Champion manufactured home.

So are these sleepy companies? Sure. Low margin? Probably. Unloved? No, not really. Shares of Recoton, which heads up the current list, have almost tripled over the past year.

This of course brings me to the point where I reveal the meaning of life. After years of painful soul searching I found that --

Rrrrringgggg!

Ah, that's the bell. Maybe we'll get around to that next time. In the meantime, do have a great weekend. Class dismissed!

Will Workshop for Fool,
Rick

[Robert Sheard is on vacation this week. He will return on August 10.]

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.]