5 Stingy Stocks for 2010
It's been a good year for Stingy Stocks. The markets still have a way to go before breaking even from the big bust, but the Stingy Stocks are very close to staging a full recovery thanks to 64.5% gains this year.
I developed the stingy method back in 2001 in an effort to beat the S&P500 by picking a subset of value stocks within the S&P500 itself. So far, the approach has exceeded my expectations. The Stingy Stocks have gained an average of 13.0% annually since 2001 whereas the S&P500 (as represented by the SPY exchange traded fund) climbed only 1.4% a year. You can see the detailed performance record in Table 1.
How do I go about selecting Stingy Stocks? I stick with companies that are both cheap and relatively safe. Not surprisingly, the combination isn't particularly common.
When it comes to bargains, I like to start with stocks trading at price-to-sales ratios of less than one. Typically only a few stocks pass this 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 this is no 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 living on the edge. 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 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 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 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 at least two or more. But it is important to remember that debt-free companies do not have to make interest payments and don't 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 debt. 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.
For a quick summary, my stingy criteria are shown in Table 2. Last year the method uncovered a veritable buffet of 19 value stocks. This year the pickings are slim with only 5 passing the test. This year's stocks are shown in Table 3. Of the bunch, Genuine Parts (GPC) is the only one to return from last year.
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, the experience of the last few years has made it abundantly clear that there is no such thing as a risk-free stock.
First published in the January 2010 edition of the Canadian MoneySaver.
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