Using the Price-to-Sales Growth Ratio to Analyze Growth Retailers
Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The price-to-earnings growth ratio can show you whether a company's upcoming earnings justify its current price. I wondered what a ratio that considered sales growth instead of earnings growth would show me, since stores that want to grow fast often put revenue ahead of sales.
So I calculated the price to sales growth ratio for a few stores, to see whether it provided different results than the PEG. My PSG definition was trailing P/S divided by expected sales growth. The PEG works pretty well for every industry, but leverage and overhead could make a cross-industry PSG comparison misleading, so I decided to test the PSG on several rapidly growing retailers.
I started with Ulta Salon (NASDAQ: ULTA), a hot beauty retailer that sells at a big premium, with a 45 trailing P/E and a 3.2 trailing P/S. Yahoo! Finance gives Ulta a PEG of 1.50, which is above the ideal PEG of 1. I don't know how fast Ulta's sales will grow over the next few years, but Ulta's sales growth for the quarter was 22%, so I plugged that into the PSG formula. 3.2 divided by 22 gave me a 0.15 PSG to use as a comparison figure.
I've compared Ulta Salon to PetSmart (NASDAQ: PETM) before, and PetSmart also sells for a premium, with a 24 trailing P/E and a 1.2 trailing P/S. PetSmart's 1.2 PEG is lower than Ulta's figure as well. Using the 9% quarterly sales growth number from Yahoo! Finance, PetSmart has a 0.13 PSG. The PSG comparison actually makes Ulta Salon look better since it supports Ulta Salon's sizable premium valuation.
I hear a lot of talk about lululemon athletica (NASDAQ: LULU), which recently shot up quite a bit after its earnings report, sending the yoga clothing store's trailing P/E up to 52 and giving the company a 1.6 PEG. Lululemon's 9.5 trailing P/S ratio is much higher than both Ulta Salon and PetSmart's P/S figures as well. Although Lululemon's 33% sales growth surpasses the other two retailers, the PSG calculation for Lululemon gives a result of 0.29, which doesn't make Lululemon look good.
Under Armour (NYSE: UA) is another hot clothing seller, with a 63 trailing P/E and a 3.8 trailing P/S. Using Under Armour's 2.1 PEG as a metric, Under Armour looks pricier than Lululemon, but Under Armour's PSG tells a different story. Dividing 3.8 by Under Armour's 27 percent quarterly sales growth gives a PSG of 0.14, in the same ballpark as Ulta Salon and PetSmart but much lower than Lululemon's PSG figure.
Since I want to focus on rapid growth companies that sell for big premiums here, my next pick was Michael Kors (NYSE: KORS), with a 55 P/E and another elevated P/S at 7.1. Michael Kors' 1.3 PEG makes it look more expensive than PetSmart, but cheaper than Lululemon, Under Armour, and Ulta Salon. The PEG comparison comes out good for Michael Kors, the PSG comes out even better. Michael Kors' 71 percent quarterly sales growth makes up for its 7.1 P/S, which gives Michael Kors a 0.1 PSG ratio that beats all four of the other companies I analyzed.
The PSG analysis did give me a few surprises. Under Armour and Michael Kors Holdings came out better than I expected, and Lululemon came out worse. An investor who had five-year revenue estimates for these companies could make more accurate calculations, since I just used the quarterly growth figures from Yahoo! Finance to get some quick estimates, but estimating 2017 sales figures is a reach anyway. Determining the ideal PSG ratio could also be tricky, since remembering that a PEG of 1 is fair and 2 is overpriced is very easy, but an industry average PSG might provide a helpful comparison.
PSG analysis did change my perspective on a few companies, so I definitely plan to use it again.
Eric Novinson owns shares of PetSmart. The Motley Fool owns shares of Lululemon Athletica and Under Armour. Motley Fool newsletter services recommend Lululemon Athletica, PetSmart, Ulta Salon, Cosmetics & Fragrance, and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.