Equity investors are always interested in identifying profitable trading strategies. The price-to-earnings ratio (P/E) and price-to-sales ratio (P/S) are two simple metrics that researchers have reported may meet this objective under particular market conditions. During our study period, which is longer in duration than most of the previous works, the performance of portfolios based on P/S dominated those based on P/E. However, portfolios based upon the combination of low P/E and net profit momentum outperformed all other strategies tested. Another way the predictive power of P/E may be improved is by dividing it by a measure of the firm's earnings growth, yielding a composite metric known as the price-to-earnings-to-earnings growth ratio (PEG). This metric has gained the attention of professional investors and researchers. Because many investors prefer P/S over P/E, it is surprising that a counterpart to PEG has not gained similar traction. Our results provide evidence that helps explain why the price-to-sales-to-sales growth ratio (PSG) has failed to gain attention. Our results also indicate that none of these market multiples alone can be employed to provide consistently profitable investment performance.

ABSTRACT

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A typical textbook definition of the weak form efficient market hypothesis suggests that past security price changes do not predict future price changes.  But a large body of empirical evidence claims that over horizons of three months to a year stock prices exhibit momentum, that is, continuation in a price direction.  This pattern of stock price momentum is exploited by some mutual funds that typically buy past stock winners and sell past stock losers.  In this paper, we show that if momentum is modified to take into consideration price patterns within the period of selection/formation, the directional momentum strategy applied to stock and/or bond no-load mutual funds proves very profitable for long term (fifteen to twenty years) investors.