Revenue-Weighting: A Price to Sales Strategy

04/11/2014 10:00 am EST

Focus: FUNDS

Forget price to earnings; this fund family's focus on price-to-sales weightings had led to above-average long-term performance. Below we talk with Vince Lowry, CEO of the RevenueShares funds.

Steve Halpern: How are you doing today, Vince?

Vince Lowry: I’m great. How are you doing?

Steve Halpern: Very good. Thank you for joining us. Your family of funds are set apart in that they focus on price-to-sales as a fundamental measure of value. Could you explain to our listeners why you have chosen this metric as opposed to more traditional evaluation methods such as price-to-earnings?

Vince Lowry: Well, what we do is, we take the S&P indices and we replicate each constituent, but we weight the constituents by their total sales, or revenues, and that becomes the weighting divided by the total revenues of the index.

And the reason for that is that we end up with a stock that, its weighting in the portfolio becomes a price-to-sales weighting and, why that is important is, as we look at the data going back, price-to-sales is a more durable and more optimal, and, I believe, over time, more accurate measurement to determine the future performance of those stocks over time.

So we decided that we’re going to stay with just that one metric, because as you go down the income statement, with revenue sales number being at the very top, and as you go down the income statement and you begin to hit various levels, whether it’s even to odd numbers netting, you get the dividends, and so on, becomes less reliable as a measurement to weight an equity in a portfolio than the top-line number.

Steve Halpern: Now, you utilize the price-to-sales measure to also assess the value of the overall market. What is your current strategy say about the general outlook for investors?

Vince Lowry: Well, the general outlook right now is that the markets are not overpriced, but they’re no longer underpriced, and, by way of example: Look at the S&P 500 that is trading, and this is the way we look at it.

If you take the entire S&P 500 (SPX) and bought that as a composite index such as buying the Spyder (SPY), you would be paying on average $1.60 to $1.62 in total capitalization for every $1 in annual revenue, so, if you put that in an historical basis, at the top, in 1999, when the market was completely overvalued, you were paying roughly $2.47 for that price-to-sales, and today, you’re at $1.62.

The long-term average, since, let’s say, 1994 forward, is about $1.51. You’re right in there, when you consider that the interest rates are, the yield curves are a little over three maybe, compared to it’s usually over six. That makes the market on that basis fairly valued at this point.

Now, if you revenue weight and do a price-to-sales of that same S&P 500 that now trades for $1.62, but you weight the stocks by their revenues, you’re paying about $0.77 for every $1 in annual revenue.

And that’s important because what we know looking at the data is that the higher the price-to-sales that you pay for a company, you’re maybe buying a great company, but the higher the price-to-sales, the faster the treadmill that company is on, and you typically end up owning a great company but a bad stock.

You’re better off earning a lower price to sales over time and a basket of stocks than a higher price to sales. The data is clear as we look back in history.


Steve Halpern: You also apply the price-to-sales measure to assess under or overvaluation within individual sectors and one where you find a level of undervaluation is in energy. Could you expand on that?

Vince Lowry: Sure. If we look at the ten sectors today in the S&P 500, the information technology sector is trading at three times revenue, and the energy sector, which is the lowest right now, is trading about $1.10 for every $1 in annual revenue.

So you can see the difference there, and if you compare that with, also, adding in the second highest, which is financial sector at $2 for every $1, and you drilled down into the financial sector and you find that these real estate investment trusts are what’s making that kind of fat compared to its history.

Many of these real estate investment trusts are trading for anywhere from five to ten times revenue, so there’s a little bubble within the financial sector.

Historically, the information technology sector has always been overweighted, but if you were looking for real value, we would put energy as number one, consumer staples as number two. Those two have the most attractive valuations right now.

Then followed by consumer discretion. We’re still seeing a lot of value in the consumer area, some bubbling effect. If you take that S&P 500 at $1.62, overall, the two sectors that are bringing that to that level is finance—the financial sector—and the information technology sector.

There’s still a lot of value in about three to four of those sectors of the ten in the S&P 500, and if you revenue weight it, you end up owning more of the undervalued sectors. By way of example, if you revenue weight, you own about 10% in technology and the cap market has about 20% to 21%.

Steve Halpern: At Revenue Shares you have several different funds for individual investors to consider. Could you briefly walk us through the available options that Revenue Shares offers?

Vince Lowry: Sure. We have the revenue weight S&P 500, so we take the S&P 500 and revenue weight that. We take the mid-cap S&P 400 index, and we revenue weight that. Then we take the Small-Cap S&P 600 and we revenue weight that.

So we have the Revenue Weight S&P 500 (RWL), Revenue Weight Mid Cap 400 (RWK), and the Revenue Weight Small Cap S&P 600 (RWJ).

On a price to sales, the Revenue Weight 400 trades at about $0.55 for every $1 of revenue, and the Small-Cap trades closer to the high 30s to low 40s in cents for every dollar.

The performance of all three of those funds versus the exact same stocks in a cap weight over since we’ve been live, we have a five-year to six-year track record now, our performance averages north of 400 basis points after fees with a small-cap over that period north of 250 basis points for the mid-cap and around a little over 200 basis points on the large-cap.

Exact same stocks with substantial out performance. The back testing that we did, these real-live data replicate almost exactly what we saw on the back testing.

Steve Halpern: Well, it’s a fascinating approach to investment, and we really appreciate you taking the time to explain that to us. Thank you for joining us.

Vince Lowry: You take care. Thank you, Steve.

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