It has been much quieter than usual around Chez Melvin so far this week. The schedule has been much lighter, so I spent a lot of time Monday and Tuesday running extensive screens and back tests of value-oriented stock selection methods. One of my favorites over the years has been the perfect stock screen. This screen simply looks for stocks trading below 90% of book value and belonging to profitable, dividend-paying companies. I then further test for balance sheet strength and long-term debt levels. I tested this screen for long-term performance, as well as trailing 12 months, and it performs very well.
Over the past 25 years this method of picking stocks has compounded at 16% compared to the broad markets return of 11%. The perfect stock approach has outperformed the broad market in 13 of the 25 years, but in several years this approach outperformed it by 200% or more. It also fared far better in bad markets, outperforming substantially in 2000-2002 and 2008. When you crunch the numbers, it is easy to see why this is one of my favorite stock screens.
Over the past 12 months the perfect stock approach has returned 18.04% including dividends. That's a little better than the S&P 500s 16.95%. When I go back and pull the list of year-ago holdings, two things stand out. First, you would have owned a lot of small stocks. A few large-cap financials like MetLife (MET) and Assurant (AIZ) made the list, but most of the perfect stocks a year ago were very small companies. The second really obvious observation is that the list was dominated by small insurance companies and banks. It was not really a diversified portfolio by any stretch of the imagination.
When I run the screen today, I find that there are a few larger cap companies. Lower energy prices have pushed the price of energy-related stocks like Rowan (RDC). Tidewater (TDW) and Gulfmark Offshore (GLF) are on this year's list of safe and cheap stocks. All three trade at significant discounts to book value and have solid balance sheets that should allow them to survive until they thrive in the future.
My three favorite insurance companies are on the list again this year. National Western Life (NWLI), American National Insurance (ANAT) and Kansas City Life (KCLI) make the grade again this year. They have been on the perfect stock list for so long, I can't recall a list that didn't have them. I have owned them forever and every time we get a significant market decline I buy a little more. There are several other insurance companies on the list, like Symetra Financial (SYA), EMC Insurance (EMCI) and United Fire (UFCS), but the big three are still my favorites.
Some of my favorite boring business, great stocks make the list of all. L.S. Starrett (SCX) could be in a more boring business if they could figure out how to get paid to watch grass grow, but beyond that it is one of the most boring companies in the world. They make measuring and cutting tools like saws, levels, measuring tape and chalk-marking devices. What is exciting about L.S. Starrett is the fact that the shares trade at less than 80% of book value, the company is profitable, has very little debt and the stock yields 2.8%.
I was delighted to see shares of Friedman Industries (FRD) finally move from almost cheap enough levels to make the perfect stock list. The company makes steel products like coils and sheet plates, and sells them wholesale to distributors. They also make tubular steel products that are used for things like pilings, oil pipelines and structural purposes. While that is not a breakthrough business by any means, it is a business that will do very well as the economy picks up over the next five to 10 years. In the meantime the stock trades at 88% of book value and has no long-term debt. Friedman Industries is profitable and pays a small dividend.
Once again, this year the perfect stock list is primarily smaller stocks. Executing a perfect stock approach to investing is also going to lead to the ownership of a lot of very cheap, financially solid small banks. I am a big fan of these trade of the decade stocks, and will have more to say about them on Friday.
Now I have to go make the stuffing and get the bird ready for tomorrow. Once again this year we will apply the Melvin Family Thanksgiving motto of nothing exceeds like excess -- and hope you and yours do the same.