As a follow-up to my column from Monday, I'd like to unveil a new group of stocks that pass my "Stocks for the Defensive Investor" screen, which aims to follow the theories of late value-investing legend Ben Graham.
This system has produced some good investment ideas over the years, although its strict parameters mean the screen typically only uncovers a handful of stocks. That's certainly true today, when value is getting harder and harder to find.
But as with many screens, the list of stocks that pass muster often changes. That's because value-related screens aim to find shares that trade cheaply for a variety of reasons that you hope the market will eventually notice.
In other words, you want stocks that meet your criteria to ultimately violate them because the shares have moved higher. (Of course, the opposite is also possible. Stocks can violate a value screen's parameters due to deterioration in one or more factors.)
As a reminder, this screen's parameters -- which I've modified a bit to account for market and economic changes since Graham originally created it -- are:
- Adequate size. A company must have at least $500 million in sales on a trailing 12-month basis. (Graham used a $100 million minimum and at least $50 million in total assets.)
- Strong financial condition. A firm must have a "current ratio" (current assets divided by current liabilities) of at least 2.0. It must also have less long-term debt less than working capital.
- Earnings stability. A business has to have had positive earnings for the past seven years. (Graham used a 10-year minimum.)
- Dividend record. The company must have paid a dividend for the past seven years. (Graham required 20 years.)
- Earnings growth. Earnings must have expanded by at least 3% compounded annually over the past seven years. (Graham mandated a one-third gain in earnings per share over the latest 10 years.)
- Moderate price-to-earnings ratio. A stock must have had a 15 or lower average P/E over the past three years.
- Moderate ratio of price to assets. The price-to-earnings ratio times the price-to-book ratio must be less than 22.5.
- No utilities. Utility stocks are out.
I ran the screen recently and found just five companies that make the cut. Let's check them out:
Westlake Chemical (WLK)
Westlake makes basic chemicals, polymers and building products, but the company's stock currently trades at just 9.5x trailing-twelve-month earnings per share and 11x 2017 consensus estimates.
WLK also enjoys a solid balance sheet. The firm ended the year with nearly $1.2 billion in cash and short-term investments (or $9 per share) against just $764 million in debt.
This well-known retailer has 297 locations in 29 states, but trades for a modest 12x trailing earnings and 11x next year's consensus estimate. The company also owns lots of real estate: distribution centers, executive-office buildings and 246 locations with 44.4 million square feet of retail space in total.
I'm not a big fan of retail these days, but we'll see where DDS goes from here.
Cooper Tire & Rubber (CTB)
This famous tire manufacturer trades for about 10x both trailing earnings and next year's consensus profit estimates.
Cooper also ended the year with $505 million in cash (or $9.12 per share), but only $296 million in debt.
Waddell & Reed Financial (WDR)
This investment-management firm's shares have lost more than 50% over the past year as redemptions and some difficulties with one junk-bond fund rattled stockholders. But as a result, WDR currently trades for only about 8x trailing-twelve-month earnings and 10x next year's consensus estimate.
The stock also offers a fat 8% dividend yield. In fact, management recently raised the quarterly payout by 3 cents to $0.46 a share.
Stage Stores (SSI)
This retailer, which operates nearly 800 stores in 40 states (primarily in smaller and mid-sized communities), has seen its shares get crushed over the past year. SSI is down more than 60% and currently trade at just 10x trailing earnings and 18x next year's consensus.
This is also another fat dividend yielder, offering a 7.75% payout (although it remains to be seen whether such a generous distribution level remains safe). Stage Stores also made a very bold move last quarter -- or maybe just a very bad one -- and repurchased about 20% of its shares outstanding for $41 million.
Now, I'm typically a big stock-buyback fan, especially when a company also pays a dividend. But again, I'm not a big enthusiast when it comes to retailers, especially struggling ones.
The Bottom Line
There you have it -- five stocks that I believe the late Ben Graham would love.
It's a mixed bag this time around, but is heavy on retail.