Studying the price the market has historically bid for a company’s sales could help in identifying when to buy or sell a stock.
Often times, large institutions like insurance companies, pension funds, endowment funds, and hedge funds buy at a certain multiple of sales.
If you can identify the historical range these institutions have paid for the company in the past, it could help indicate levels to buy or sell. Finding these past relationships seems complicated, but using GuruFocus.com’s Interactive Chart feature makes it quite easy.
Let’s start with the chart below. This chart depicts McCormick & Company Inc.’s Market Capitalization in blue and trailing 12 months revenue in green.
Market capitalization is the price to buy all the stock of a company. It fluctuates up and down substantially as the investing public becomes greedy and fearful.
Trailing 12 months revenue is the value of McCormick & Company Inc.’s sales for the past year. This green sales line is much less volatile but does change over the years.
Notice how MKC’s Market Cap. (price) in 1996 was below the green line (TTM revenue) and by 2005 was way above. Fast forward to the end of 2008 and notice how Market Cap retraced towards the green line. This decline occurred during the most recent recession when many institutions were fearful and desperate to sell.
Below is a chart of McCormick & Company Inc.’s price-to-sales ratio starting in 1998. This chart is created by taking the Market Cap and dividing it by Revenue. It includes the same numbers as the chart above, but depicts it in an easy to understand chart. Click the “P/S Ratio” tab in Interactive Chart to enable this feature.
To interpret why this chart is important, we take the recent level of 2.3 and compare it to the past. The range is from a low of .89 in 2000 to a high of 2.47 in 2013. We then examine what happened to price after it hit these levels.
What happened to the price of McCormick & Company Inc. after institutions bid .89 times the level of sales?
Below is a chart depicting MKC’s price increase after 2000. Those buying during the two year period when MKC was below the 1.25X sales level saw a 150% increase in price.
Below is a chart of the price increase in percent after 2009 when MKC once again hit the 1.25x sales level. Those buying near historical P/S lows had major price gains, this time 125%.
Another feature that helps identify opportunity and risk is the “Price at Med P/S” tab. This concept is simply the Price MKC would be if it traded at the Median P/S ratio. Half the time MKC trades above this level and half the time below. Below is a chart that features this.
The further below the blue Median P/S line the Green Price line goes, the larger a discount you get on MKC sales. Way above this line, the more danger there may be in buying MKC.
For those who purchase MKC in November 2014, when the P/S ratio is at 2.25x sales, will this time be as profitable as when MKC was trading below 1.25x sales?
Remember, revenue is what you buy and price is what you pay.
Thank you to GuruFocus.com for the Interactive Chart feature that enables these graphics.
