Sifting the Street's rubbish
Value isn't easy to define, much less find. For those of us constantly seeking stocks on the cheap, the most obvious "value" suspects are companies in deep distress, the kind of thing Benjamin Graham might have been happy to pick up. I'm talking about something like Wheeling-Pittsburgh
While this company looks like a bargain to me, it's most certainly a high-risk value, best fitted into that small portion of the portfolio that some of us Fools call the "dog doo." It's relatively easy to look for ideas like this on the 52-week-low list, the problem being that many of these stocks will never get off that list until they go to zero and disappear altogether.
To find somewhat safer values, I employ a technique that my colleagues at Motley Fool Inside Value use: screening. A visit to the dedicated message boards will give you an idea of the variety and complexity of the screens that some of my colleagues and community members use to look for deals. Me, I'm always looking for something simpler.
Stealth values
A couple of months back, I began looking for companies that fit my definition of "stealth values" -- stocks that might not cross the radar of the value hunter who generally looks for very deep discounts, but that nonetheless show reasonable discounts to their long-range potential. They should also possess some kind of strong franchise -- a brand name, a competitive advantage, one of those intangibles that can ease downside risk.
To gather the original contenders, I came up with some pretty simple criteria -- emphasis on "simple." I was aiming for a screen that anyone could perform with a basic online screening tool. Here's how easy things can get:
- Growth in earnings per share between 10% and 25% over the past five years.
- Trading at a price-to-earnings (P/E) ratio between 8 and 20.
- Trading at a 10% discount to its average P/E ratio over the past half-decade.
- Market capitalization of less than $10 billion.
After straining for companies with recognizable consumer franchises, my original contenders were:
Current P/E |
5-Yr. Avg. P/E |
Market Cap (Billions) |
|
---|---|---|---|
Brunswick |
11 |
16 |
$3.6 |
H&R Block |
14 |
14 |
$7.8 |
Lexmark |
14 |
25 |
$5.1 |
Ruby Tuesday |
18 |
16 |
$1.3 |
Stanley Works |
16 |
20 |
$3.8 |
Tiffany |
17 |
24 |
$5.6 |
Wolverine World Wide |
17 |
22 |
$1.3 |
Yankee Candle |
14 |
19 |
$1.1 |
Of those, I previously set aside H&R Block, Yankee Candle, and Lexmark, and I judged Brunswick fit enough for my "lazy portfolio" -- you can read about that here. Ruby Tuesday looked interesting two months ago, but having run up a good 20% from then, I don't think it's cheap enough anymore. (Note to self: Sometimes when you snooze, you lose.) Of the remainders, two companies still stand out to me -- companies that display the kind of solid long-term financial returns that can mean great things when they're underappreciated.
Boots and bucks
For a company named after a scary animal, Wolverine the stock can be downright boring. This company is an integrated shoemaker. It's best known for work boots and shoes, but it also operates segments that do everything from tanning shoe leather to selling end products to customers. Despite some pretty solid earnings, again and again, the stock hasn't done much moving. For value-oriented pickers, that should be just fine.
The company's core brands and partnerships are familiar names to many, including Hush Puppies, Caterpillar
As I said, Wolverine's recent numbers have been nothing to snarl at. Some might point out that Wolverine's margins, at just under 11%, are a lot less than Timberland's 15% or Nike's 14%, but I look to this as future potential. In fact, one of my biggest winners of this year -- a company that turned in a 120% gain -- is a company that had lukewarm sales gains but continuing success in lifting margins toward its peers' averages.
In that spirit, I think the trend is what is important here, and if you look back at Wolverine's history, you see margins increasing at a measured pace.
Margins | ||||||
---|---|---|---|---|---|---|
2000 | 2001 | 2002 | 2003 | 2004 | TTM | |
Gross Margin % | 34.1 | 35.7 | 35.6 | 36.7 | 37.7 | 38.6 |
Operating Margin % | 9.9 | 10.4 | 9.3 | 9.0 | 10.1 | 10.7 |
Net Income Margin % | 1.5 | 6.3 | 5.8 | 5.8 | 6.6 | 7.1 |
Moreover, Wolverine's returns on assets, capital, and equity have also shown consistent improvement over the past half-decade.
Investment Returns, Wolverine | ||||||
---|---|---|---|---|---|---|
2000 | 2001 | 2002 | 2003 | 2004 | TTM | |
Return on Assets % | 8.5 | 9.0 | 9.0 | 8.9 | 10.1 | 10.8 |
Return on Capital % | 9.7 | 10.5 | 10.6 | 10.7 | 12.6 | 14.1 |
Return on Equity % | 3.2 | 12.7 | 12.9 | 12.9 | 14.8 | 16.8 |
This is a company that has made a habit of doing the right things with its resources, a character also evidenced by share buybacks that actually reduce the share count, thereby benefiting shareholders.
Tooling up
Stanley Works is a company that's also pretty familiar to anyone who's ever strolled the tool department at Home Depot or the local hardware store. Its screwdrivers and hand tools are well known, but the rest of the biz, such as storage, hardware, industrial tools and assembly systems, and security solutions provide a lot of the growth that the company has shown over the past years. Let's refine that: Acquisitions of companies into the Stanley family have provided a lot of that growth.
While I'm normally pretty wary about companies that grow via acquisition, Stanley seems to be one of those that does it right. While it has taken on new product portfolios, it's also not shy about taking a pass on operations that don't fit its plan. As a result of this discipline, and a realization of the "synergies" that often don't come in conglomerates, Stanley Works has been able to make its acquisitions deliver not only on the top line but also on the bottom.
You can see evidence of this by looking at gross margins, which have remained firm, at a bit above 36%, and operating margins, which have grown slightly despite the work of integrating new businesses and now rest at about 13.9%. Like Wolverine, Stanley also boasts good investment returns, with return on capital growing from 10% two years back to 14.6% today, and return on equity rising from 17.3% to 22.2% over the same stretch.
Another reason I like Stanley Works these days is that I think whenever there's a housing hiccup, or just fear of a hiccup, the Street rushes to discount everything construction-related, often with undue prejudice. For all my grousing about the housing bubble, I don't believe homebuilding is just going to stop, kersplat. And even if it slows markedly, companies that provide tools and hardware don't depend entirely on new building for their revenues. When people don't build, they need to fix, which means they need the same hardware and tools.
That said, I did like Stanley Works a bit better a couple of months back, when I first ran this screen and it was trading closer to $44 per share. Cheap Fools (like me) may choose to hold out for that buy-in point. But anyone planning to hang onto shares for the long term will, I think, have a market-beater here. What's more, the company yields a decent 2.4% dividend at today's prices.
Foolish bottom line
Analyses like these really are more art than science. Though Yankee Candle looks too risky to me, Philip is intrigued enough to have added it to his Inside Value Watch List, a "wait-and-see" section of the newsletter that has later produced several official picks.
And while I like Wolverine and Stanley, there are ideas at Inside Value that Phillip has vetted more thoroughly. Who knows -- if history is any guide, Wolverine and Stanley could someday join his picks -- though not until they get a bit cheaper, I'd bet.
Stocks like 3M and Home Depot are among several companies that Phillip and I ended up eyeballing at the same time and eventually made his cut, and both have produced market-beating returns so far. Do great minds -- or at least cheap minds -- think alike? Where do you fit in? A free trial will help you find your inner value hound, whether you like your stocks dirt cheap and dangerous, or whether you prefer a healthier, stealthier deal.
For related Foolishness:
- See what Philip (a former shipping captain) thinks of the "values" in the shipping biz today.
- Take another look at Buffett's stealth values.
- But be careful you find stealth values and not steel deathtraps.
Seth Jayson is always looking for a deal. At the time of publication, he had shares of 3M and Home Depot but no positions in any other stock mentioned. View his stock holdings and Fool profile here. 3M and Home Depot are Motley Fool Inside Value picks. Fool rules are here.