Plowback Screen Plowing Along
By Jim Stevens (Jim Stevens)
BURLINGTON, VT (August 5, 1999) -- Today we check in on another market-beating Workshop screen, the Plowback model. Our interest in this screen began last year in the 05/19/98 report. Since then, a lot of us have gotten interested in this simple ratio, a favorite of Warren Buffett for choosing winning companies. A few months back TMF Elan added some legitimacy to the model when he ran and posted a backtest of the Plowback screen. Elan's test shows that a 5-stock version of the screen would have had a compound annual growth rate of 30.41% from 1986 through 1998.
So what is this Plowback Ratio? Value Line actually calls it Percent Retained to Common Equity and defines it as "Net profit less all common and preferred dividends divided by common equity including intangible assets, expressed as a percentage." Put more simply, it looks at ratio between profits retained by the business (i.e. not paid out in dividends) and the company's net worth or "common equity," which is the company's assets minus its liabilities.
The theory behind this screen is that companies that continually "plow back" profits into their businesses believe in themselves. The current profits are used to drive future growth.
Here's a quick primer on how to run the Plowback screen: Starting with all 1700 stocks in the ValueLine Investment Survey, select the 20 stocks with the largest market capitalization that also have a plowback ratio of 25% or greater. Very simple, really, but you do need the electronic edition of ValueLine to run the numbers. For the final selection, choose the top 5 or 10 stocks with the highest 26-week Total Return.
At the beginning of 1999, I began tracking a Plowback Ratio portfolio in my Three Experimental Screens report. Up through last Friday, here's the performance the top 20 Plowback stocks for 1999, selected based on the December 31, 1998 ValueLine:
Sun Microsystems (Nasdaq: SUNW) 56.93% Oracle Corp. (Nasdaq: ORCL) 26.09% Int'l Business Mach. (NYSE: IBM) 34.37% Intel Corp. (Nasdaq: INTC) 7.75% Dell Computer (Nasdaq: DELL) 8.28% Amgen (Nasdaq: AMGN) 38.08% Cisco Systems (Nasdaq: CSCO) 31.72% Safeway Inc. (NYSE: SWY) -16.72% Guidant Corp. (NYSE: GDT) 7.05% Gap (The) Inc. (NYSE: GPS) 25.61% Lucent Technologies (NYSE: LU) 24.16% Microsoft Corp. (Nasdaq: MSFT) 31.32% Schering-Plough (NYSE: SGP) -7.47% Abbott Labs. (NYSE: ABT) -12.12% Campbell Soup (NYSE: CPB) -19.89% Sara Lee Corp. (NYSE: SLE) -20.62% Bestfoods (NYSE: BFO) 31.52% Caterpillar Inc. (NYSE: CAT) 39.95% Coca-Cola (NYSE: KO) -5.78% Computer Associates (NYSE: CA) 15.10% Top 5 26.69% Top 10 21.92% Top 15 15.68% All Twenty 12.22%1999 is shaping up to be another good year for the model, with the relative strength (26-week Total Return) once again proving to be an effective final ranking tool.
Here are the top ten Plowback stocks as of last week's ValueLine:
Tellabs Inc. (Nasdaq: TLAB) Sun Microsystems (Nasdaq: SUNW) Int'l Business Mach. (NYSE: IBM) Amgen (Nasdaq: AMGN) Colgate Palmolive (NYSE: CL) Nokia Corp (NYSE: NOK) Gap (The) Inc. (NYSE: GPS) Lucent Technologies (NYSE: LU) Cisco Systems (Nasdaq: CSCO) Microsoft Corp. (Nasdaq: MSFT)Stay Foolish!