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Many investors look towards various key ratios as a way to determine the value of a company. The most common one is the price-to-earnings, or P/E, ratio. Value investors use the P/E ratio to determine if a stock is cheap. The lower the ratio the cheaper the company.

However, the P/E ratio has its flaws. It is easier to manipulate earnings than other aspects of a company's performance. That's why I like to also use the price-to-sales, or P/S, ratio when I'm looking for top stocks.

What Is The P/S Ratio?

The P/S ratio uses the market capitalization of a company and divides it by the past 12 months' revenues. A low price-to-sales ratio is preferred as that means an investor is paying less for each sale.

It is more difficult for a company to tweak sales performance, than it is to influence earnings, since it's pretty straightforward. Therefore, the P/S ratio can be a better indicator of hidden value than the P/E ratio.

What Ratio Do You Want To See?

Just like with the P/E ratio, the lower the P/S ratio is, the better.

When seeking out attractive fundamentals, you want to look for companies with P/S ratios under 1.0 as that usually indicates value. But it can also be helpful to compare a company's P/S ratio with those in its industry. Again, you want it to be lower than those in its industry as that indicates that it is paying less than its competitors for its sales.

Don't Only Use the P/S Ratio

The P/S ratio is not perfect. It shouldn't be the only fundamental you're screening for.

It doesn't take debt into account so a company can have a low P/S ratio but mounds of debt and therefore might not be a good investment. It also doesn't account for expenses, which can affect profit.

But if you combine the P/S ratio with other indicators, such as the P/E ratio, and then put the Zacks Rank on top of that, it can be a powerful combination for finding attractive stocks.

I did just that and found the following three companies, all of which are cheap value stocks as well as Zacks #1 Rank (Strong Buys).

3 Stocks With Dream P/S Ratios

  1. Phillips 66
  2. Trinity Industries
  3. HanesBrands

1. Phillips 66 (PSX - Snapshot Report) Phillips 66 has a well known name but the company is "new" having been spun off from ConocoPhillips in early 2012. Phillips 66 is one of the largest independent refiners in the U.S. with 15 refineries and 15,000 miles of pipelines.

The favorable crack spread is currently holding at around the $20/Bbl level. The industry refinery utilization rate has also stabilized. The company is generating big cash flow and recently raised its quarterly dividend by 25%. It currently yields 2.2%. It's really cheap.

P/S ratio = 0.1
Forward P/E = 6.5
Zacks #1 Rank (Strong Buy)

2. Trinity Industries, Inc. (TRN - Snapshot Report)

Trinity Industries is one of the largest railcar manufacturers in North America. It also makes inland barges, highway guardrail and crash cushions and its energy division makes structural wind tower and tank containers. Railcars are seeing strong demand. As of June 30, 2012, the company had a $3.2 billion railcar backlog.

P/S ratio = 0.7
Forward P/E = 10.1
Zacks #1 Rank (Strong Buy)

3. HanesBrands (HBI - Analyst Report)

HanesBrands makes basic apparel and lingerie under several well known name brands such as Hanes, Champion, Playtex, Bali, Wonderbra and Gear for Sports.

On Oct 3, it reaffirmed full year guidance based on consumer and retail trends through mid- to late September, including the Back to School selling period.

P/S ratio = 0.7
Forward P/E = 12.7
Zacks #1 Rank (Strong Buy)

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Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Turnaround Trader and Insider Trader services. You can follow her on twitter at @TraceyRyniec.

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