NEW YORK (Real Money Pro) -- If stock market investors have a favorite variable to focus on, it likely is earnings.
They study the price-to-earnings ratio, look closely at earnings growth rates and hang on every word that is uttered during earnings calls.
However, not every savvy investor is so enamored by earnings.
Ken Fisher, the best-selling author, money manager and Forbes columnist, thinks that sales are more revealing than earnings. He found that earnings are far more volatile than sales because everyday decisions, such as replacing equipment or upping research and 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.
Although 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 the year ends, I want to acknowledge my Fisher-based strategy as a star long-run performer. This strategy, which I based on his 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% during 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 that my Fisher-based strategy pinpoints as worth investing in is Winnebago Industries (WGO) - Get Free Report , the iconic recreation vehicle manufacturer known particularly for its motor homes. 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 earnings per share 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 Automotive has a very strong P/S of 0.64.
Free cash flow is positive, earnings per share are growing rapidly and the company's three-year average net profit margin is 6.27%.
This article was originally published on Dec. 31 at 10 a.m. EST on Real Money Pro.
At the time of publication, Reese and his clients were long WGO and TRW, although holdings can change at any time.
John P. Reese is founder and CEO of
, an investment research firm, and
, an asset management firm serving affluent investors and companies. He is also co-author of two investing books, including
(Wiley). Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback.
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