5 Stingy Stocks for 2008
[Stingy Stocks for 2009]
I look for two qualities when hunting for bargain stocks: they must be cheap and relatively safe. Not surprisingly, it is often difficult to find stocks that are both cheap and safe.
When it comes to cheap, I seek stocks with low prices in relation to book value, earnings, sales, or cash flow. It is best to initially search for cheap stocks using only one or two of these fundamental values because each search reveals a slightly different list of interesting stocks. When composing my annual Stingy Stock list for the Canadian MoneySaver I stick to stocks with price-to-sales ratios of less than one.
Stocks with low price-to-sales ratios are cheap but I also want some assurance that they won't go bust. Because large firms tend to be more stable than smaller firms, I stick to stocks in the S&P 500.
More importantly, companies with little debt and lots of assets are much stronger than firms living on the edge of insolvency. Three ratios are very 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 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 one are often too high. I prefer very conservative companies with even less debt and look for debt-to-equity ratios of 0.5 or less.
Next up is the current ratio which is calculated by dividing a company's current assets by its current liabilities. Current assets are defined as 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 within 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 company's creditors will demand prompt payment of the current liabilities. On the other hand, some current assets, such as a firm's inventory, might not actually be worth as much as management expects.
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 two or more. But it is important to remember that a debt-free company does not have to make interest payments and wouldn't have an interest coverage figure. Nonetheless, debt-free firms should not be excluded from consideration.
While the debt ratios that I've selected are very useful in determining a firm's ability to shoulder debt, they are not perfect. Some long-term obligations may not be fully reflected on a company's balance sheet and are, sensibly enough, called off-balance sheet debt. Regrettably, off-balance sheet debt is often ignored but it can be a source of considerable consternation. For instance, sneaky legal liabilities can sideswipe what might otherwise be a good investment. As with all screening techniques, be sure to 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.
All of my criteria are summarized in Table 1. I've used these rules to find interesting value stocks over the last six years with some success as shown in Table 2. Unfortunately, last year was disappointing and my stocks slipped 5.5%. The Stingy Stocks also trailed the S&P 500's gain of 7.4% which ends a five-year streak of beating the S&P 500.
Even with a loss this year, the Stingy Stocks provided a total gain of 168.0% since 2001. That's assuming the old stocks were sold and the new stocks were purchased each year. In comparison, the S&P500 (as represented by the SPY exchange-traded fund) lagged by 125.9 percentage points over the same period with a gain of 42.1%.
This year the pickings remain slim with only five stocks making the grade. The Stingy Stocks for 2008 are shown in Table 3 and you'll notice that there are several repeats this year. Ashland (ASH), Genuine Parts (GPC), and Leggett & Platt (LEG) get the nod as they did last year. New to the list are Robert Half (RHI), a professional staffing firm, and Convergys (CVG), a HR and customer management technology firm.
I hope that I've piqued your interest, but be sure to fully investigate each stock, and talk to your investment advisor, before investing. Remember, although the Stingy Stocks are relatively safe, there is no such thing as a risk-free stock.
First published in the December 2007 edition of the Canadian MoneySaver.
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