Three Stocks That Pass Two Tough Tests

 | Jul 11, 2014 | 10:00 AM EDT
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My colleague Jim Cramer is a master stock-picker. That's not news to any informed stock market investor. I am also a stock-picker. My picks are based on computerized investment strategies that I modeled on the techniques of some of Wall Street's most successful investors.

The market offers many successful ways to invest, including the approaches of Jim and of each of my guru strategies. Because Jim's strategies and mine differ in their analyses, overlapping recommendations are unusual.

Right now, though, we are in one of those unusual periods when Jim's recommendations and those of one of my strategies, in this case the one based on the work of James P. O'Shaughnessy, largely overlap. Recommendations from both Jim and my O'Shaughnessy-based strategy make compelling cases for you to consider buying these stocks.

Last week, Jim wrote about several companies whose stock prices are up sharply since the Dow hit 16,000. He said that a sharp price rise does not preclude further price increases. He then gave plenty of compelling reasons why the stocks he wrote about may well go higher.

My O'Shaughnessy strategy also indicates that some of these stocks are destined to continue to go heavenward. Of those Jim mentioned, the O'Shaughnessy strategy shows further upside for Cisco Systems (CSCO), the giant maker of routers, switches and other Internet infrastructure; Merck (MRK), one of the world's largest pharmaceutical companies; and Intel (INTC), the huge designer and manufacturer of computer chips.

One thing you need to know about the O'Shaughnessy strategy is its emphasis on holding a portfolio of stocks that you have picked on the basis of the same strategy. You generally shouldn't cherry-pick one stock that you prefer. Even the best guru strategy (and I've studied quite a few) is right no more than 60% of the time in its picks over the long term. The success in the strategy comes because the stocks that are winners show average gains that far outperform the ones that are losers.

In this regard, the O'Shaughnessy strategy is no different from many other strategies. But if you are going to invest in one of these picks because it passes both the O'Shaughnessy strategy and the judgment of Jim Cramer, you should divide your new investment dollars equally across all three.

Also, the O'Shaughnessy strategy comes in two flavors: growth and value. The three companies just mentioned are favored by the value-oriented strategy, which is a bit of a surprise, since two of the stocks are tech companies, which are generally thought of as growth opportunities. But the two tech companies in question, Cisco and Intel, are huge, well-established market leaders, and the expectations for growth from these companies are seen as muted. That creates the value opportunity as these companies continue to rack up profits.

Here are the variables employed by the O'Shaughnessy strategy:

  • Market cap must be over $1 billion.
  • Cash flow per share must be greater than the mean of the market cash flow per share ($1.72).
  • Shares outstanding must exceed the market's average number of outstanding shares (628 million shares).
  • Trailing 12-month sales must be at least 1.5x greater than the mean of the market's trailing 12-month sales per share ($21.1 billion).

The strategy's final step is to select the 50 companies that have passed the above tests and have the highest dividend yield.

The market caps of all three companies are well over $100 billion, cash flow per share easily exceeds the strategy's minimum, as do the number of outstanding shares. Plus, each company's trailing 12-month sales is more than double the strategy's minimum. Each of these companies easily beats the strategy's requirements. They all also have decent dividend yields: Cisco 3.02%, Merck 2.97% and Intel 2.89%.

These three companies are market leaders with enviable track records. And since they earn accolades from both Jim Cramer and my O'Shaughnessy strategy, finding companies with stronger recommendations will be very tough.

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