Here is a starting-point for choosing among large-company stocks: basic valuations of the stocks in the S&P/TSX 60 index. The figures in the accompanying table are raw material for making investment choices.

The ratios show how the stock market is valuing these companies by three fundamentals: book value, cash flow and sales per share. As ranked by the ratio of stock price to book value, they range from “growth” stocks at the top of the list to “value” stocks at the bottom. These are static but fundamental relationships based on known data, rather than valuations based on estimates of future growth and earnings.
There is another advantage to using these numbers. Book value, cash flow and sales are harder numbers measuring corporate performance than stated earnings, which are more of an estimate or judgment call.

The 60 stocks are the cream of the Canadian market in size and liquidity. They also tend to be less volatile than shares of smaller companies and stocks with smaller floats.

Note how high the price/book value ratios are. A stock is at or near bargain level when it trades at no more than 1.4 or 1.5 times book value, and only a dozen S&P/TSX 60 stocks fit into, or come close, to this range.
This shows that most “value” stocks are not historically cheap — a strong sign that the overall market is still pretty highly valued.

Mind you, price/book value is not the decisive factor in selecting a portfolio, although groups of stocks trading at low price/book do outperform groups of high price/book stocks in the long run.

There may be surprises for stocks leading the “growth” contingent. We expect to see stocks such as Research in Motion Ltd. and Cognos Inc. heading the list. But the presence of a blue chip stalwart such as Imperial Oil Ltd. near the top shows how well the market views energy stocks.

A way to assess these stocks by “growth” and “value” is to view the top third as clear-cut “growth” stocks, the bottom third as “value” and those in the middle as undecided.

The price/book value comparison applies across all stocks, but the other two ratios should not be applied too broadly.
Price/cash flow ratios tend to fall into industry categories, with greatly favoured stocks trading at extremely high multiples.
Stocks trading in low single-digit multiples of cash flow do fall into the “bargain” category, unless other tests indicate unusual risk.

You should use price/sales ratios narrowly, by comparing stocks within an industry.
Retail stocks, for example, typically trade at low price/sales ratios. A price/sales ratio that might reveal Loblaw, for example, as very highly valued might show Imperial Oil as ridiculously cheap. As it is, the current Loblaw price/sales ratio appears rather high.

A “high” price/sales ratio for an established, stable company in ordinary times was around 1.5. That rule of thumb also says any stock — even a hot technology stock — trading above three times sales is risky.
These parameters have been fractured in the past eight or 10 years, but the principle is there. A high price/sales ratio compared with other companies in the same industry or similar industry is a signal for caution.

There are other things to consider when choosing a stock. But price/book value, price/cash flow and price/sales ratios are basic tools in evaluating an investment. With these ratios as a starting point, you can narrow your search for firms you may want add to a portfolio or sell.

A few words on ratios: they come from yearend fiscal 2004 data, with a few exceptions, and mid-April stock prices. Most corporate fiscal yearends are Dec. 31. For RIM, ATI Technologies Inc. and Cognos, with yearends earlier in the calendar year, recent 12-month figures are used.

Nortel Networks Ltd. has yet to produce its final word on fiscal 2004, so that line is a blank. Kinross Gold Corp.’s annual report has also been delayed by its desire to have assets reappraised; its price/book value ratio is based on the latest number available. IE