The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 8

An Advertisement for Super Stocks and Forbes

How do you know when a stock is really cheap? Most people use price/earnings ratios. What if the company isn't making money, so it doesn't have a P/E? Then try price/sales ratios (PSRs). PSRs effectively value stocks, particularly at the very times when P/Es won't work. I made my name in the investment world by doing research into and publicizing the results of using PSRs, so they are dear to my heart. This chart exemplifies how PSRs pay off when the more conventional use of P/Es won't.

You should never buy a big company's stock unless the company's total stock market value is less than 40 percent of the company's annual revenues—preferably much less. That means the stock's PSR is less than 0.40 (40 percent equals 0.40). So, if a company had $10 billion in annual sales, its stock market value must be less than $4 billion to be considered. If it had 100 million shares and its stock were 35, it would be OK ($3.5 billion market value), but if the stock were 45, it then would be too high.

This chart starts before Sears's big 1927–1928 run-up. Sears peaked in 1928 and fell most of 1929—so you might have thought it was cheap—particularly when its price fell enough to lower its P/E ratio to just 12 in mid-1929. Most folks think a P/E of 12 is rather cheap. But P/Es are often misleading too, and while no one knew it, Sears' earnings were about to collapse. From its 1929 low, Sears lost another 90 percent in three years. That's where ...