Walk up to any graduate student in finance. Ask her to design a stock-picking screen. I’ll bet you a milkshake that she will design something more complex than my Old Faithful stock-selection paradigm. Yet my picks in this column drawn from Old Faithful have averaged more than a 19% return per 12 months, more than double the average return for the Standard & Poor’s 500 Total Return Index.
To qualify as an Old Faithful stock, a stock must be based in the United States and meet six criteria:
· Profitable, with a return on equity 15% or better.
· Debt under control, less than equity.
· Stock price no more than 15 times earnings.
· Stock price no more than two times revenue.
· Stock price no more than 2 times book value (corporate net worth).
· Growing, with earnings growth averaging 10% or more over the past five years.
Here are a few stocks that intrigue me, drawn from the latest Old Faithful screen.
Westlake (WLK) is a chemical company based in Houston, Texas. Among its products are epoxies, which are important in making blades for wind power stations.
Even though Westlake has grown its earnings at a 14% annual pace the past five years, its stock price is barely above where it was five years ago.
A minor concern I have is that Westlake has some production facilities in China. Given the tense relationship between China and the United States, this might pose a problem at some point.
An ocean shipper based in Hawaii, Matson
MATX
is one of the cheapest stocks I know, selling for three times earnings. Due largely to the pandemic, ocean freight rates have risen as much as tenfold in the past three years on many shipments.
Investors expect freight rates recede. Reasonable, but I doubt they will back close to 2019 levels. Matson has shown a profit in each of the past 15 years, and profits have been fat lately.
The collapse of Silicon Valley Bank and Signature Bank
SBNY
led investors to throw a lot of regional bank stocks overboard. I think the selloff was overdone.
Among the knocked-down bank stocks I like is Farmers & Merchants Bancorp. (FMCB), which based in Lodi, California and serves many towns in southern California. Revenue has grown at a 10% annual clip the past five years, and earnings considerably faster. The stock sells for 10 times earnings.
I think homebuilders as a group are undervalued now. Mortgage rates have risen and affordability is an issue, so investors are skittish. But there is pent-up demand for houses.
One homebuilder that I like is KB Home
KBH
, which typically sells homes in the $480,000-to-$500,000 range, an above-average price point. Lately its return on equity has been about 23%, which is quite good. Yet the stock sells for less than book value.
Hibbett (HIBB), based in Birmingham, Alabama, runs a chain of some 1,100 sporting goods stores in 35 states. The stock price, which hit $90 about two years ago, has receded to about $58, which is only six times recent earnings and less than 0.5 times sales, a bargain in my book.
Over the past decade, Hibbett has increased its earnings have at an 11% annual clip. Because it concentrates on small and medium-sized cities, Hibbett is often the only sporting goods store in town, which helps keep the profit margin up.
Track Record
I’ve written about Old Faithful almost every year since 1999, with a three-year blackout in 2007-2009. My Old Faithful selections have been profitable in 14 out of 20 years, and have beaten the S&P 500 total return in 15 of those years.
In 20 outings, the average return has been 19.96%, far above the 7.22% for the S&P 500 over the same periods.
Bear in mind that my column results are hypothetical and shouldn’t be confused with results I obtain for clients. Also, past performance doesn’t predict the future.
Last year’s result was nothing to write home about. I beat the S&P’s performance, which was negative 2.11%, but still had a 0.49% loss. Returns for my five picks were all over the place. D.R. Horton (DHI) had a 45% return and Timken
TKR
was up 34%. But Intel
INTC
fell 33%, Capital One
COF
28% and Lithia Motors
LAD
22%.
I hope for better returns on this year’s crop.
Disclosure: I own Matson personally and for most of my clients. I own Intel personally and for some clients.
John Dorfman is chairman of Dorfman Value Investments LLC in Boston, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at jdorfman@dorfmanvalue.com.
Read the full article here