When I'm in the market to add to my portfolio, I often turn to stock screens to help me find stocks that may be worthwhile investments. The benefit of a stock screen is that it can narrow down the thousands of stocks in the U.S. markets to hundreds or even tens of stocks in no time. The downside to a stock screen, however, is that it's inherently dumb and can't do much to evaluate two of the factors that are most important to me: strength of the business and quality of management.
My starting point this time around was looking for stocks with:
- An EBITDA multiple below seven (why you should use EBITDA multiples).
- A market cap above $500 million.
- A debt-to-equity ratio below 100%.
- A return on capital above 8%.
- A dividend yield above 2%.
- No operating losses over the past 10 years.
I then sorted the list based on the total dollar value that insiders own.
With that first pass done, it's time to do a second pass that takes a look at the business and management of each company to figure out whether it's worth a closer look or it can be knocked off the list.
Let's dig in.
Business: I currently own Microsoft and a big part of the reason is the strength of its entrenched business-software business. And while many of the company's pushes outside of its core markets have fallen flat, the success of the Xbox shows that Mr. Softee can score outside of its traditional sweet spot.
Management: For CEO Steve Ballmer, the plus side includes the fact that he's dedicated his career to Microsoft and owns a substantial stake in the company ($10 billion, give or take). In addition, in the 12 years since Ballmer took over as CEO, Microsoft's operating profit has grown by an average of 8% per year. For a company as large as Microsoft, that ain't bad at all. On the other hand, as Microsoft's industry has shifted, it seems to have been caught largely flat-footed and has thus far been a solid also-ran in key areas such as search and mobile.
Bottom line: There's more than enough to like here to keep Microsoft on my short list.
Business: I'm not crazy about any company that has a huge amount of customer concentration -- even when that customer is the ostensibly deep-pocketed U.S. government (which accounts for around 70% of General Dynamics' revenue). As the nature of combat changes, I also wonder what the appetite will be for product like tanks and submarines.
Management: It's really hard to argue with having a formal Navy admiral and member of the Joint Chiefs of Staff run a defense contractor. Though CEO Jay Johnson doesn't have a ton of private-industry leadership experience -- he was an executive at Dominion Resources just prior to General Dynamics -- both former CEO Nick Chabraja and the longest-serving board member, James Crown, seem to have a good deal of confidence in Johnson. Chabraja has more than $100 million in General Dynamics stock, while Crown's stake is above $1 billion.
Bottom line: The company's leadership is compelling, but the business turns me off. This is a pass for me.
Business: Pretty much everyone is familiar with Best Buy's business. Big-box, electronics-focused retail is what Best Buy rode to considerable success. The world has changed drastically, though, and while electronics are as popular as ever, low-price and online competitors like Wal-Mart and Amazon.com are making life really difficult for the erstwhile champ.
Management: Management has been in flux at Best Buy ever since former CEO Brian Dunn was pushed out due to a scandal. Just recently, the company hired Hubert Joly, formerly of Carlson Cos. -- the parent of Radisson, Carlson Wagonlit Travel, and T.G.I. Friday's. Joly doesn't have retail experience per se, but as my fellow Fool Dan Newman pointed out, he has plenty of the customer service experience that Best Buy is in need of.
Bottom line: I'm not sold on the business, I'm not sold on management, and I'm not comfortable simply making a bet on founder Richard Schulze's proposed buyout getting done. That said, the latter would probably be best from the company's standpoint -- it could overhaul its business without the constant scrutiny and second-guessing of Wall Street.
Business: Although Occidental is one of the top-five largest oil and gas companies in the U.S., it gets seriously overshadowed by the others at the top -- particularly ExxonMobil, Chevron, and ConocoPhillips. Why the recognition disparity? It's most likely because while the names "Exxon," "Chevron," and "Conoco" are plastered all over signs on gas stations throughout the U.S., Occidental doesn't have a downstream segment that refines crude oil and sells it to drivers through retail locations. Instead, Occidental focuses on upstream -- that is, actually getting hydrocarbons out of the ground -- midstream -- storing and transporting them -- and chemicals. The company also has a not-insignificant trading arm that was bolstered when it bought Phibro (famous for its $100 million man, Andrew Hall) from Citigroup.
Management: One of the first things that jumps out at me about Occidental's management is the outsized pay packages given to its top executives. In 2011, Executive Chairman Ray Irani was paid nearly $50 million, while CEO Steve Chazen was handed $32 million. Compare that to Rex Tillerson at Exxon -- a company more than five times the size of Occidental -- who was awarded $35 million. I'm also not crazy about the fact that the company is being run by a former investment banker -- Chazen was a mergers and acquisitions specialist at Merrill Lynch prior to joining Occidental. On the other hand, Occidental's record under Irani speaks for itself -- operating income is 35 times what it was two decades ago, and it has an annual growth rate of 19%. While Irani is handsomely rewarded by the company, he also owns more than $700 million in Occidental stock, which is no small commitment.
Bottom line: I'm lukewarm on management, but the business intrigues me. This one will make my short list.
Business: Two things immediately turn me off about Buckle's business. In the first line of the business description in the company's annual report, it says that it caters to "fashion-conscious young men and women." For all of the concern that Warren Buffett has expressed over the years about investing in technology companies because of the specter of change, fashion is at least as bad, if not worse. Second, the majority of Buckle's sales (68% in 2011) are branded products from other manufacturers. That puts it in a tough position -- if your store is the only place I can get something then I need to shop there. Otherwise, why am I shopping with you? Lower price? Convenience? I'm bored and walking off my ill-conceived Sbarro lunch?
What Buckle had going for it for some time was small size and room to grow. That's not as much the case anymore. At the end of 2011, it had 431 stores. American Eagle had 911 of its brand-name stores open at the beginning of this year, but Abercrombie & Fitch only had 294 (plus 571 Hollister stores) and Urban Outfitters had all of 427 stores if you combine its Urban Outfitters, Anthropologie, and Free People concepts.
Management: The management angle is much more interesting here. Dan Hirschfeld is the chairman, the company's founder, and owner of more than a third of the company. He's joined by CEO Dennis Nelson, who started at the company as a part-time salesman (!) in 1970 and worked his way up through the ranks. He owns 6% of the company. This is obviously a pair of executives that are not only intimately knowledgeable about this business, but heavily invested in it as well.
Bottom line: I want to like Buckle, but the business "wins" here for me -- that is, I'm not crazy about a teen-fashion retailer that may be pushing the limits of how much it can grow.
Line 'em up!
I wish I had come away with more than two companies that I'm excited to dig into, but it's better than nothing. While I've got plenty more companies from my screen to still take a look at, both Microsoft and Occidental Petroleum are now on my short list for more research.
Want to keep an eye on these companies? Add them to your Motley Fool watchlist:
Yes, you can also add the others, too, if they are more interesting to you than they were to me:
- Add General Dynamics to your watchlist.
- Add Best Buy to your watchlist.
- Add The Buckle to your watchlist.
And if you want to get up to speed quickly on the opportunity (and risks) in Microsoft's stock, a great place to start is with the new Motley Fool premium report "What You Should Know About MSFT." Click here to find out how to get a year of quarterly updates on Mr. Softee's stock.
The Motley Fool owns shares of ExxonMobil, Citigroup, Best Buy, General Dynamics, Microsoft, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Microsoft, Chevron, Dominion Resources, The Buckle, and Amazon.com. Motley Fool newsletter services have recommended creating a synthetic covered call position in Microsoft. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
Fool contributor Matt Koppenheffer owns shares of Chevron, Microsoft, and Wal-Mart, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.