Only one new stock met Austin, Texas-based investor Donald Yacktman’s rigorous standards for inclusion in his funds this past quarter: Sigma-Aldrich Corporation (NASDAQ:SIAL), a stock whose price has been going up fairly steadily since 2009. Yacktman bought 564,100 shares for his Yacktman Fund in the first quarter, and 484,400 shares for his Yacktman Focus Fund, for $77 shares in the first quarter. A closer look at the company and Yacktman’s investment criteria suggests why he might like it.
The two most crucial elements of Yacktman’s stock selection strategy are forward rate of return and quality of the company. Focus on such criteria has delivered a market-beating 12.58% average annual return over the past 10 years for his Yacktman Fund (YACKX), versus 8.53% for the S&P 500.
Categorized in the chemicals sectors, Sigma-Aldrich, his new buy, is a life science and high technology company making biochemical products for the scientific genomic and proteomic research, biotechnology, pharmaceutical, disease diagnosis and high technology manufacturing markets. It services more than 1.3 million scientists and technologies and operates in 40 countries.
The $9.31 billion market cap company has seen its stock rise almost 32% over the past five years, to trade for $77.59 on Friday.
Yacktman defines forward rate of return as the normalized free cash flow yield plus real growth plus inflation. In other words, it is the return that investors in the stock today can earn from it in the future.
GuruFocus handily covers metric this for every stock in its global indexes. Sigma-Aldrich has a 13.28 forward rate of return as of year-end 2012, as seen in the chart below:
- Warning! GuruFocus has detected 7 Warning Signs with SIAL. Click here to check it out.
- SIAL 15-Year Financial Data
- The intrinsic value of SIAL
- Peter Lynch Chart of SIAL
SIAL data by GuruFocus.com
By comparison, Yacktman’s top holdings have the following forward rates of return:
News Corp. (NASDAQ:NWS) – 5.15
Procter & Gamble (PG) – 4.38
PepsiCo (NYSE:PEP) – 13.83
Microsoft (NASDAQ:MSFT) – 12.51
Cisco (NASDAQ:CSCO) – 15.14
Quality, another Yacktman criterion, is harder to define, but manifest in Sigma-Aldrich in several ways, primarily in its balance sheet. The company has been generating growing free cash flow over the past 10 years, hitting a record $453 million in 2012:
SIAL data by GuruFocus.com
In addition, cash far outweighs liabilities. Sigma-Aldrich at year-end 2012 had $1.08 billion in cash, and only $573 million in long-term liabilities and debt. Debt to equity in the past three years has also declined to its lowest levels since 2004:
SIAL data by GuruFocus.com
GuruFocus gives the company a business predictability rate of 4-star. The average gain of 4-star stocks is 9.8% per year, and the percentage of stocks that are still in a loss if held for 10 years is 8%.
More recently, Sigma-Aldrich reported a quarterly record diluted EPS of $1.01, compared to $0.96 in the year-ago quarter, and quarterly record sales of $675 million, a 2% year-over-year increase.
Recently, it formed three new market-facing business units, Research, Applied and SAFC Commercial, that are seeing progress. The company said headwinds from large pharma site consolidations over the last several years were beginning to cease, contributing to improvements in its Research segment, but it is still facing the impact of government sequestration and European funding uncertainty. Sales in the segment declined 1% year-over-year.
In its Applied business unit, sales to diagnostics and testing labs increased in the high single digits, mid-single digit organic sales growth was seen in its SAFC Commercial unit driven by life science products and services, and it is launching new products for semiconductor and electronic display markets as prices decline in the LED industry.
In the first quarter, Sigma-Aldrich raised its dividend by 8% -- marking its 38th consecutive year of increases. The company has an attractive dividend yield of 1.04%, and an 8.4% dividend growth rate – higher than 96% of the companies in the global specialty chemicals industry.
While Sigma-Aldrich has good aspects, Yacktman likely does not believe it shows quite as much promise as his larger positions. He reserves larger weightings in his portfolio for companies that more strongly demonstrate the qualities he looks for, and SIAL occupies just 0.51% of his portfolio – two spaces higher than Research In Motion (NASDAQ:BBRY).
“We think position sizing is one of the most important aspects of good portfolio management,” he said in his 2012 annual letter. “We generally take bigger positions in higher quality, diverse companies that we think can acceptably compound capital at attractive rates of returns or securities that are extremely mispriced due to investor perception issues. At times you may see us take surprising positions in companies that have business challenges like Research in Motion, but we use our investment experience to determine when we can take a significant position weighting and when we should not.”
To see more of Donald Yacktman’s stock picks, visit his portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Donald Yacktman.