Investors often do not consider sales growth as a dependable metric when it comes to picking stocks. This might be because of their preconceived notion that a company’s stock price is typically sensitive to its earnings momentum. However, betting on stocks completely depending on such a perception may not prove worthwhile.
It’s worth keeping in mind that in cases when companies incur a loss, albeit transitorily, they are valued on their sales not earnings. This is because top-line growth (or decline) is usually an indicator of a company’s future earnings performance.
Notably, in contrast with price to earnings and price to book value ratios, which can turn negative and cease to be relevant, the price-to-sales (P/S) ratio is available even for firms that have hit choppy waters.
Further, a company can improve earnings by resorting to cost control measures while maintaining stable revenues. However, superior profits could be achieved through continued revenue growth.
Also, earnings and book value are largely influenced by several factors including accounting decisions tied with depreciation, significant charges and inventory. However, management has limited opportunities to manipulate sales, which further underscores the importance of P/S ratio.
A huge sales number does not necessarily convert into profits. Therefore, considering a company’s cash position along with its sales number can prove to be more prudent. Substantial cash in hand and a steady cash flow lend a company more flexibility with respect to business decisions and investments.
Selecting the Winning Stocks
In order to shortlist stocks that have witnessed impressive sales growth along with a high cash balance, we have selected 5-Year Historical Sales Growth (%) greater than X-Industry and Cash Flow more than $500 million as our main screening parameters.
But sales growth and cash strength are not the absolute criteria for selecting stocks. So, we added certain other factors to arrive at a winning strategy.
Price-to-Sales (P/S) Ratio less than X-Industry: This metric determines the value placed on each dollar of a company’s revenues. The lower the ratio, the better it is for picking a stock since the investor is paying less for each unit of sales.
% Change F1 Sales Estimate Revisions (four weeks) greater than X-Industry: Estimate revisions, better than the industry, are often seen to trigger an increase in stock price.
Operating Margin (average last five years) greater than 5%: Operating margin measures how much every dollar of a company’s sales translates into profits. A high ratio indicates that the company has good cost control and sales are increasing faster than costs — an optimal situation for it.
Return on Equity (ROE) greater than 5%: This metric will ensure that sales growth is translated into profits and the company is not hoarding cash. A high ROE means the company is spending wisely and is in all likelihood profitable.
Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.
Here are five of the 27 stocks that qualified the screening:
Bristol-Myers Squibb Company BMY discovers, develops, licenses, manufactures, markets and distributes biopharmaceutical products. This New York-based company’s expected sales growth rate for 2018 is 7.8% and it sports a Zacks Rank #1.
Based in Stamford, CT, United Rentals, Inc. URI operates as an equipment rental company. Expected sales growth rate for the current year is 18.9% and the stock carries a Zacks Rank #2.
Capital One Financial COF, headquartered in McLean, VA, is primarily focused on consumer and commercial lending as well as deposit origination. Its expected sales growth rate for 2018 is 3% and the stock carries a Zacks Rank #2.
Headquartered in Voorhees, NJ, American Water Works Company, Inc. AWK provides water and wastewater services. The company’s expected sales growth rate for 2018 is 1.8% and it carries a Zacks Rank #2.
Harris Corporation HRS provides technology-based solutions that solve government and commercial customers’ mission-critical challenges. This Melbourne, FL-based company’s sales are expected to increase at the rate of 7.2% for fiscal 2019.The stock carries a Zacks Rank #2.