This week, I'm going to focus on the Price to Sales ratio for finding great stocks at great values.

The Price to Sales ratio is a great valuation metric. And given the recent run-up in stocks, value, to me, is becoming more and more important.

In fact, aside from the Zacks Rank, if I could only use one item to screen and pick stocks with, this item would be the one.

Definition

Let's first start with a definition.

The Price to Sales ratio is simply: Price divided by Sales

If the Price to Sales ratio is 1, that means you're paying $1 for every $1 of sales the company makes.

A price to sales ratio of 2 means you're paying $2 for every $1 of sales the company makes.

As you might have guessed, the lower the Price the Sales ratio, the better.

A price to Sales ratio of .5 means you're paying 50 cents for every $1 of sales the company makes.

And paying less than a dollar for a dollar's worth of something is a good bargain.

One of the reasons I like the Price to Sales ratio is because it looks at sales rather than earnings, like the P/E ratio does.

And sales are harder to manipulate on an income statement than earnings.

Secondly, I'd be hard pressed to find a screen where adding the Price to Sales ratio didn't improve it.

Price to Sales Study

For me, I prefer to look for stocks with a Price to Sales ratio under 1. Although, I'm willing to go up to 4, depending on the industry.

But in my testing, as the illustration below shows, those with a Price to Sales ratio of 1 or less produced the best returns. Between 1 and 2 also outperformed pretty significantly. But once you got over 4, the odds were against you.