Discipline is key to sustainable long-term total returns.

At Laffer Tengler, we use two, time-proven stock valuation metrics (both pioneered by our team) that are consistent and robust indicators of value: Relative Dividend Yield (RDY) and Relative-Price-to-Sales Ratio (RPSR).

Why don’t we use earnings like almost everyone else? Because earnings are often an unreliable indicator of value. In May of 2016, our Chief Investment Officer, Nancy Tengler, published the following:

“Earnings reported by corporations have always been subject to the vagaries of accounting gimmickry. You don’t have to be a novice to scratch your head at the way managements (or governments for that matter!) account for various items.

A recent case in point: The Wall Street Journal (Thursday, February 25, 2016) reported that according to FactSet, pro forma earnings for S&P 500 companies rose 0.4% in 2015. Using generally accepted accounting principles or GAAP, earnings per share actually fell 12.7% in 2015 (this according to S&P Dow Jones Indices). The author’s point is that according to GAAP earnings, investors are paying a great deal more for stocks than they think. The price-to-earnings ratio (P/E) on pro forma earnings (which is the most commonly accepted method) is 17x 2015 earnings. But when GAAP earnings are considered, the P/E jumps to more than 21x.”

It is important to remember that the P/E ratio for any given stock is only as good as the price input (a fact) and the reported earnings input (apparently not a fact at all).

RDY (Relative Dividend Yield) measures the yield of a particular stock compared to the yield on the S&P 500 and does so over long periods of time. Since a stock’s relative yield and relative price are inverse, we can generally conclude that as a stock’s yield is rising, its price is declining—similar to a bond. Consequently, a rising RDY provides an opportunity for investors to at least consider an underperforming, cheaply valued stock for purchase.

Company managements and boards of directors pay the dividend out of free cash flow, not earnings. In maturing U.S. companies these seasoned professionals often operate within a “dividend paying culture” and set the dividend as a portion of long-term, sustainable real earnings power because management teams are loathed to cut dividends.

The relative nature of the RDY metric is also important because it measures the relative attractiveness of a stock compared to its own history and compared to the S&P 500. (In 1992, I coauthored Relative Dividend Yield, Common Stock Investing for Income and Appreciation with Tony Spare).

RPSR (Relative Price-to-Sales Ratio): In fallen-angel growth companies where the dividend is less of a factor in management’s calculus, we look at sales—a fact. Rarely are sales manipulated and when they are someone usually goes to jail. The price-to-sales ratio measures how much investors are paying for a unit of sales, the relative price-to-sales ratio reveals what investors have historically paid for a particular company’s sales compared to what they are paying for the sales of all the companies in the S&P 500.

Discipline, in summary, is the only way to navigate volatile markets. We remain disciplined and over time that consistency generates excess return.

Fundamental Research reduces the ownership of terminally cheap companies: Meet the 12 Fundamental Factors.

Our proprietary research approach analyzes fundamental qualitative and quantitative factors.

Qualitative Factors: Buggy Whip Factor (product obsolescence), Niche/Franchise Value, Management and the Board.

Quantitative Factors: Sales Growth, Operating Margins, Positive and Growing Free Cash Flow, Dividend Coverage and Dividend Growth, Asset Turnover/Quality, Investment in Business/ROIC, Equity Leverage/Balance Sheet, Relative P/E and Financial Risk.