3 Stingy Stocks for 2014
I started the Stingy Stock method in 2001 in an effort to beat the S&P500 by picking value stocks within the index itself. I'm pleased to say the results have exceeded my expectations.
Over the last year the Stingy Stocks have climbed by an average of 37.8% while the S&P500 (as represented by the SPY exchange traded fund) advanced only 29.7%. Both fared well but the market trailed by 8.1 percentage points.
Naturally it is unwise to expect returns north of 30% each and every year. But the Stingy Stocks have done quite well over the long term. They're up an average of 17.3% annually since 2001 whereas the S&P500 (SPY) has moved ahead only 6.4% a year. Despite a few ups and downs along the way, the Stingy Stocks have outperformed the index by 10.9 percentage points a year on average and the full performance record is shown in Table 1.
How do I go about picking Stingy Stocks? I look for companies that are both cheap and relatively safe, which, as it turns out, can be an uncommon combination.
On the bargain front, I like stocks trading at price-to-sales ratios of less than one. Typically only a few stocks pass the test and this year was no exception.
Cheap stocks are great but I also want some assurance they won't go bust. That's why I stick with firms in the S&P500, which tend to be large and relatively stable. But that isn't 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 companies perched precariously on piles of IOUs.
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 debt by its shareholder's equity. The amount of debt that a company can comfortably support varies from industry to industry but debt-to-equity ratios of more than 1 can be too high. I prefer very conservative companies with debt-to-equity ratios of 0.5 or less.
The next balance sheet figure to consider 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 can 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 turn out to 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.
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, a business is less likely to go bust when it is profitable and has cash coming in the door.
That's a daunting list of requirements and I've summarized the primary factors in Table 2.
Last year the method uncovered 8 value stocks but this year the list shrank to a mere 3 as the market moved higher. It's not a pleasing development and it indicates that value stocks are becoming rather scarce.
Details on the 3 stocks for 2014 are shown in Table 3 where you can see each stock's dividend yield and multiple of sales (P/S), earnings (P/E), and cash flow (P/CF).
I hope the method piques your interest, but be sure to fully investigate each stock before investing. The Stingy Stocks might be relatively safe, but there is no such thing as a risk-free stock.
First published in the February 2014 edition of the Canadian MoneySaver. Performance numbers are based on the dates in the data table and do not represent calendar year figures.
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