Tuesday, May 26, 1998
by Greg Markus (TMF Boring)
Costa Mesa, Calif. (May 26, 1998) -- Following Asian markets lower, the U.S. stock market fell sharply, dropping 1.5%. The Bore fell with it. Only Pentair and Atlas Air gained ground for the Borefolio today, and perhaps we should be thankful for even this small favor on a day like today. Rather than dwell on it, though, we still have cash in our portfolio and we've been looking for new areas to invest. Sometimes you find ideas through unlikely circumstances.
I've been on the road a lot during the past few months -- well, up in the air, actually. Looking for something to read on my flight out to LAX from Detroit last week, I spotted a copy of a month-old edition of Fortune in the overhead bin. This one happened to be the magazine's annual Fortune 500 edition.
As the name implies, this edition features the largest half-thousand U.S. companies, ranked in terms of annual revenues. More interesting to me than the information about how companies stack up in terms of sheer size, however, were the listings of the top 50 companies among the 500 when ranked according to various measures of growth and profitability.
Of all the various measures of a firm's performance, perhaps one of the most straightforward and most useful is "return on assets," or ROA. ROA answers the simple question, "For every dollar that a company has tied up in assets -- its cash and investments, receivables, inventories, plant, property and equipment, 'good will' and so forth -- how many cents of net profit did it produce?"
It's in the interest of a company's investors (which is to say, its collective owners) to pay attention to ROA, because if their company manages to generate, say, only a three or four percent average annual return on total assets, then one might legitimately ask if it might not make more sense simply to sell off the assets and invest the proceeds in Treasury bonds.
When the 500 largest U.S. firms are ranked in terms of their 1997 ROA, one immediately begins to understand that companies with high ROAs tend to be companies that have done exceptionally well for shareholders. Taking the top three slots for 1997 are "Cash-Kings" Coca-Cola (NYSE: KO), Intel (Nasdaq: INTC), and Microsoft (Nasdaq: MSFT), with ROAs of 24.4%, 24.0%, and 24.0%, respectively. The Boring Portfolio's favorite technology company, Cisco Systems (Nasdaq: CSCO) shows up in 8th place, with a 19.2% ROA.
A number of other investments of the various portfolios operated here in The Motley Fool also appear on the list -- names like 3Com (Nasdaq: COMS) with a 1997 ROA of 16.5%; Gap Stores (NYSE: GPS), 16.0%; Johnson & Johnson (NYSE: JNJ), 15.4%; Pfizer (NYSE: PFE), 14.4%; and Campbell Soup (NYSE: CPB), 11.0%.
It will come as a surprise to no one that few if any of the stocks of these ROA leaders are cheap on a price-to-earnings basis. High returns -- and particularly consistently high returns -- come with a price. Perhaps more significantly, nearly all of the aforementioned stocks are not only expensive on a valuation basis relative to other stocks, they are also expensive relative to themselves. That is to say, they are nearly all trading at p/e altitudes (computed retrospectively or prospectively) that they have rarely if ever visited before.
This being a market, buyers and sellers of these stocks obviously have different opinions about how high is "too high" and whether or not prevailing (and projected) economic environments warrant historically high valuations right now. That's not the argument I want to have today, though.
Instead, I'd like to say a few words about another aspect of Fortune's Top-50 ROA list that caught my eye. And this being a section of the Motley Fool devoted to "Boring" stocks, it should come as no surprise that what I noticed was that sprinkled among the well-known stocks on the list were many fine companies that toil in less glamorous fields but that nonetheless generate impressive returns on assets.
For example, Fleetwood Enterprises (NYS: FLE) makes manufactured (which is to say, "pre-fab") homes and recreational vehicles -- not exactly a glam business. Yet Fleetwood cranked out an ROA of 14.3% last year, just a tenth of a percentage point behind mighty Pfizer.
Moreover, analysts expect Fleetwood to grow its EPS by around 15% in the coming year -- or about double the projected growth rate for the S&P 500. Yet at a current price of around $42, FLE trades at only 14 times projected EPS for its fiscal year ending April 1999. The stock sports a decent dividend, too, of about 1.6%.
Of course, Fleetwood's stock may well be cheap for a good reason, just as Pfizer's may be dear for a good reason (such as its latest drug having already become a household word -- at least among the adult members of the household). Is the home-building industry at or past the peak of its cycle? Might oil prices recover from current depressed levels, thereby depressing motor-home sales? Might Chairman Greenspan and his colleagues at the Fed conclude later this year to tweak U.S. interest rates higher by a notch or two, thus smacking both the housing and RV markets right between the eyes?
Dunno. But Fleetwood might at least be worth a look as a possible investment.
Fleetwood is not the only potential Borefolio material that appears on Fortune's Top-50 ROA list. There's also Dover (NYSE: DOV), a fine diversified industrial corporation that reminds me a lot of the Borefolio's Carlisle Companies (NYSE: CSL) and Pentair (NYSE: PNR). Dover took 28th position on the list, with an ROA of 12.4%.
Electrical products distributor W.W. Grainger (NYS: GWW) holds down the 33rd slot, with an ROA of 11.6%. And specialty chemical producer Rohm & Haas (NYSE: ROH) topped 445 of the 500 largest corporations in America last year with an ROA of 10.5%.
Stocks of these highly profitable but lesser-known companies generally trade at multiples below that of the S&P 500, yet they offer above-average growth prospects, if analysts' estimates are to be believed.
If you have opinions about any of these companies (and their stocks), I -- and other participants here in Fooldom -- would love to read what you have to say. You can always reach the Boring Portfolio message board from the top right of this page. We hope to see you there.
Stock Change Bid ANDW - 1/4 21.38 CGO + 1/16 35.38 BGP -1 1/4 32.00 CSL - 5/8 48.25 CSCO - 7/8 75.94 FCH - 9/16 34.06 PNR + 5/16 42.50 TBY - 1/8 10.00
Day Month Year History BORING -1.43% -1.54% 1.59% 27.83% S&P: -1.48% -1.60% 12.74% 75.99% NASDAQ: -1.49% -4.83% 13.23% 70.81% Rec'd # Security In At Now Change 2/28/96 400 Borders Gr 11.26 32.00 184.29% 6/26/96 150 Cisco Syst 35.93 75.94 111.33% 8/13/96 200 Carlisle C 26.32 48.25 83.29% 3/5/97 150 Atlas Air 23.06 35.38 53.42% 5/20/98 400 TCBY Enter 10.05 10.00 -0.45% 4/14/98 100 Pentair 43.74 42.50 -2.84% 11/6/97 200 FelCor Sui 37.59 34.06 -9.38% 1/21/98 200 Andrew Cor 26.09 21.38 -18.07% Rec'd # Security In At Value Change 2/28/96 400 Borders Gr 4502.49 12800.00 $8297.51 6/26/96 150 Cisco Syst 5389.99 11390.63 $6000.64 8/13/96 200 Carlisle C 5264.99 9650.00 $4385.01 3/5/97 150 Atlas Air 3458.74 5306.25 $1847.51 5/20/98 400 TCBY Enter 4018.00 4000.00 -$18.00 4/14/98 100 Pentair 4374.25 4250.00 -$124.25 11/6/97 200 FelCor Sui 7518.00 6812.50 -$705.50 1/21/98 200 Andrew Cor 5218.00 4275.00 -$943.00 CASH $5429.76 TOTAL $63914.14