Hitching a Ride with a Comeback Sector

 | Oct 11, 2011 | 10:15 AM EDT
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A company in a specific industry just came to a labor agreement, where it promised to add 12,000 jobs, bring work back to the U.S. from Mexico, China and Japan, invest $6.2 billion in its U.S. plants during the contract's four years and give most of its workers guaranteed bonuses of at least $12,000.

Another member of this industry also recently signed a labor pact that included some notable promises, including creating 6,400 jobs at American plants, bringing work home from Mexico and raising its entry-level pay. And this same industry's sales jumped 9.9% in September.

If you haven't guessed, it's the American automobile industry. On its knees in 2008 and 2009, the industry is in the midst of a significant comeback, along with the kindred truck industry. The two companies I referred to above are Ford (F) first and then General Motors (GM).

It should be no surprise to learn some auto and truck makers are doing well enough to earn your consideration as investments. To choose stocks, I use strategies that mirror methods created by some of Wall Street's greats, and one of these strategies, based on the writings of James P. O'Shaughnessy, likes two car companies.

Neither are American, nor as badly hit by the recession as Ford and General Motors, so their recovery had less of a hill to climb than their American counterparts. Also, one is strictly in the truck business and other is a major truck producer, making their improving performance less dependent on automobiles. But the car and truck markets have certain commonalities and the improving prospects for Ford and General Motors boosts the prospects of most car and truck makers around the world.   

Before I discuss these companies – Daimler (DDAIF) and Volvo (VOLVY) – let's review O'Shaughnessy strategy. Prior to the appearance of quants on Wall Street – math driven, computer-aided traders – there was O'Shaughnessy. He did not use the logarithms and other advanced mathematical techniques to play the market that today's quants use, but he gave a great deal of value to numbers and studied the market carefully to decipher patterns.

Specifically, he back-tested decades of Standard & Poor's data to look for patterns that suggested successful strategies. He then wrote about his findings in the seminal "What Works on Wall Street," on which I base my O'Shaughnessy strategy. Since I started tracking the strategy in July 2003, it has produced an average annual return of 8.4% vs. 1.4% for the S&P 500 during the same time period.

The strategy incorporates five variables:

  1. Market cap: must be $1 billion or more
  2. Cash flow per share: must be greater than the mean of the market's cash flow per share, which at this time is $1.32
  3. Shares outstanding: must be in excess of the market's average, which is 615 million shares
  4. Trailing 12-month sales: must be at least 1.5 times greater than the mean of the market's trailing 12-month sales, which is $19.2 billion
  5. Those stocks that pass the previous criteria are then screened for their dividend yield. The 50 companies with the highest yield receive the strategy's highest grade

Of the two car and truck companies that score so well, Daimler -- the maker of Mercedes-Benz cars, as well as the Maybach and smart car -- is one of the world's most storied producers of luxury automobiles. By unit sales, it is the second-largest truck producer in the world. Why should you buy it? Because it earns the O'Shaughnessy strategy's highest grade. This is a result of its market cap ($48.6 billion), bountiful cash flow per share ($11.05), large number of shares outstanding (more than 1 billion), huge sales ($137.1 billion) and robust dividend yield (5.54%).

Volvo is a major manufacturer of trucks, buses, aircraft engine components and diesel engines, among other products. It is completely separate from the maker of Volvo cars. It sold its car manufacturing operations in 1999. What the O'Shaughnessy strategy likes about Volvo: its market cap ($22.9 billion), cash flow per share ($2.03), shares outstanding (2 billion), sales ($19.2 billion) and dividend yield (3.84%).

It's time to hitch a ride with these companies is now.

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