Finding bargain stocks can be a real challenge this year. The S&P 500 index has returned over 11% year-to-date (only a few months into the year), which follows last year’s surprisingly strong 18% return. Nearly 250 stocks have more than doubled in price since January 1, suggesting that the market is frothy.
Contrarian investors look where others don’t. One metric that can help uncover bargains is the EV/sales ratio. This measure compares a company’s enterprise value (EV) to its revenues. Enterprise value can be thought of as what a company is worth if you owned it outright, with no debt or excess cash. EV is calculated as the sum of the market value of the equity, plus all debt, less cash.
The trendiest companies and those in the early stages of development sell at high EV/sales multiples. Today, this group includes biotech, electric vehicle and software firms in which investors have high expectations for future growth, even if many currently are producing little in the way of revenues. Cloud services provider Snowflake (SNOW), with an enterprise value of $63 billion, trades at 57x its estimated 2021 revenues of $1.1 billion. The $7.5 billion enterprise value of Fate Therapeutics (FATE) is 288x its tiny $26 million in sales. Clearly, these are not bargains.
On the other end of the spectrum are companies with low EV/sales multiples. These tend to be low-margin companies as well as those in cyclical, capital intensive industries. Also, they may have strategic challenges or uncomfortable stories that investors prefer to avoid. Yet, among these otherwise uninspiring companies may be legitimate bargains.
3 Bargain Stocks with Favorable EV/Sales Ratios
Value-oriented investors will want to put this metric into their stock screening toolkit. Some interesting bargain stocks that our recent low EV/sales screen yielded include:
Cardinal Health (CAH) – One of the three firms that dominate the pharmaceutical distribution industry, Cardinal trades at 0.13x estimated 2021 revenues of $161 billion. Much of this low valuation is due to its razor-thin operating profit margin of about 1.2%. Also, the company is challenged by stalled increases in pharmaceutical prices (which curtails its buy-low-now, sell-higher-later profits), changing healthcare regulations and some operational difficulties with its Medical segment. However, its low valuation, stable profit margins, hefty free cash flow and 3.2% dividend yield make this stock worth a closer look.
Office Depot (ODP) – This company would appear to be on the wrong side of two major trends: the decline of physical retail stores and the shift to a paperless, digital office. Yet, trading at only 0.34x its $9.4 billion in revenues, Office Depot shares have appeal. Its physical stores remain a valuable source of business, while its transition to online/digital is proving to be quite successful. The work-at-home trend is providing an additional healthy tailwind. Its finances are surprisingly strong, backed by generous free cash flow as the company boosts its operating efficiency. Office Depot is weighing a buyout offer from privately-owned competitor Staples at $40/share (the shares are currently trading slightly above this price), but it is rebuffing this offer as inadequate compared to its stand-alone value. While the shares will likely sink if anti-trust regulators reject the deal, contrarians will want to take a look at this interesting company.
Spartan Nash Company (SPTN) – Like most distribution companies, Spartan Nash operates with narrow profit margins of about 2%. A “middleman,” the company is pressured by its increasingly powerful customers (grocery stores and other food retailers) and suppliers (food producers), as well as by volume changes from end-consumers. While recent results were mildly encouraging, a likely post-pandemic pantry de-stocking would increase the pressure on Spartan Nash’s margins. However, there appear to be aggressive changes underway. A new CEO was appointed in September, the board chair is stepping down, and several top managers are being replaced. This intriguing stock was picked up by our low EV/sales ratio screen, as it trades at only 0.17x EV/sales. Its modest 11x EPS multiple also suggests a possible bargain.
With Cabot’s contrarian investment strategies, we do all the extensive screening and research work to help you benefit from out-of-favor stocks. I use it in my Cabot Turnaround Letter advisory to save you time while boosting your chances of profitable investing. To learn more about the Cabot Turnaround Letter, click here.