5 Stingy Stocks for 2011
Our Stingy Stocks climbed a phenomenal 69.4% this year and that marks the second year in a row that they've gained more than 60%.
While I'd like to attribute the advance entirely to superior intelligence, a generous dollop of good fortune was certainly involved. Nonetheless, the Stingy Stocks now boast an enviable long-term track record.
I started the method in 2001 in an effort to beat the S&P500 by picking value stocks within the S&P500 itself. So far, the Stingy Stocks have gained an average of 18.3% annually since 2001 whereas the S&P500 (as represented by the SPY exchange traded fund) climbed only 2.6% a year. That's an average outperformance of 15.7 percentage points a year. (The sterling yearly performance record is shown in Table 1.)
How do I select Stingy Stocks? I stick with companies that are both cheap and relatively safe which is an uncommon combination.
When it comes to bargains, I like stocks trading at price-to-sales ratios of less than one. Typically only a few stocks pass the test and this year is no exception.
Cheap stocks are great but I also want some assurance that they won't go bust. Stocks in the S&P500 are large and such firms tend to be more stable than most but it is hardly a guarantee.
Because size is an insufficient measure of safety, I also look for companies with little debt and lots of assets. Such firms are stronger than debt-laden companies. Three ratios are useful when searching for companies with little debt. Perhaps the most important is the debt-to-equity ratio which is calculated by dividing a company's long-term debt by shareholders' equity. The amount of debt that a company can comfortably support varies from industry to industry but debt-to-equity ratios of more than one are often too high. I prefer very conservative companies with debt-to-equity ratios of 0.5 or less.
The next useful figure is the current ratio which is calculated by dividing a company's current assets by its current liabilities. Current assets are assets, such as receivables and inventory, that are expected to be turned into cash within the next year. Current liabilities are payments that the company must make over the next year. Naturally, an investor would like a company's current assets to be much more than its current liabilities and I prefer companies with current assets at least twice as large as current liabilities. After all, you can be pretty sure that a firm's creditors will demand prompt payment of the current liabilities. On the other hand, some current assets, such as inventory, might not be worth as much as expected.
Finally, a company's earnings before interest and taxes should be large in comparison to its interest payments. The ratio of earnings-before-interest-and-taxes to interest-payments is called interest coverage and I like this ratio to be at least two or more. But it is important to remember that debt-free companies do not have to make interest payments and may not have an interest coverage figure. Nonetheless, debt-free firms should not be excluded from consideration.
While the debt ratios I've selected are useful in determining a firm's ability to shoulder debt, they are not perfect. For instance, some long-term obligations may not be fully reflected on a company's balance sheet and are, sensibly enough, called off-balance sheet debts. Regrettably, off-balance sheet debt can be a source of considerable consternation. Things like unexpected legal liabilities can sideswipe what might otherwise be a good investment. That's why, as with all screening techniques, you should embark on a more detailed investigation of each stock before making a final investment decision.
Continuing the safety theme, I also want a company to show some earnings and cash flow from operations over the last year. After all, it is less likely that a business will go under when it is profitable and has cash coming in the door.
That's a daunting list of requirements but I've summarized the primary criteria in Table 2.
Last year the method uncovered 5 value stocks and it spotted the same number this year. The full list is shown in Table 3. Of the bunch, only long-time holding Genuine Parts (GPC) returned again from last year's list.
I hope that I've piqued your interest, but be sure to fully investigate each stock before investing. Remember, although the Stingy Stocks are relatively safe, there is no such thing as a risk-free stock. Furthermore, I should hasten to add that you should not expect 60% returns to be a common occurrence. Don't get me wrong, I'd be more than pleased to see the good run continue but it seems wise to have much more modest expectations.
First published in the January 2011 edition of the Canadian MoneySaver.
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