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Ten Performance Bargains for 2009
Posted by: Dr. Paul Price (IP Logged)
Date: January 1, 2009 07:10AM

This article from Seeking spotlighted two stocks that DaveinHackensack and I have written about here plus one other that I own but have not commented on here [SNHY].

» From Seeking Alpha
by: Marc Gerstein January 01, 2009

Previous blogs in this bargain-hunting series have spotlighted book value, cash, lack of debt and divined income as themes that could provide opportunities in this bear market. But we ought not ignore the most basic factor of all, one that should play well not just in times of crisis but in any kind of market: a strong track record of above-average corporate performance.

The Performance Bargains screen

There are countless ways to identify good, fundamentally-strong companies, some simple and straightforward, others very complex. When times are good and stock prices are high, it's often necessary to devise obscure tests of quality, not so much because such companies will really be better, but because we need to work harder to find firms whose merits have yet to be fully appreciated in the investment community. But now, with the market so badly shaken, with shares of great companies having been trampled as badly as shares of laggards, we have the luxury of being more direct in how we define good performance.

After establishing a basic universe (no OTC or ADRs, no Finance stocks, Market Cap at least $250 million and Price at least $5), this screen uses the following simple rules:

EPS growth exceeds the industry average for the trailing 12 month and five-year periods.
This is about as simple as it gets. If you poll investors for what they look for in a desirable company, it's hard to imagine many, if any, not having EPS growth near or at the top of the list. The above rules evaluate EPS growth over the past five years and the trailing 12 months. It's tempting to require a minimum growth rate, as many do on most occasions. But now, with business conditions as bad as they are, it seems like doing this might too easily drive the result set down toward zero. So to be realistic, I'm happy if a company has a consistent track record of outperforming industry peers.

Return on Investment exceeds the industry average for the trailing 12 month and five-year periods.

Return on investment is not likely to loom large in a poll asking Wall Street practitioners for their favorite characteristics. But it (or some variation, like return on equity) is one of the textbook favorites. And even if not always in the conscious awareness of practitioners, it's still valuable to them, since companies that consistently generate strong corporate returns are the ones that often have the greatest capacity to produce good rates of EPs growth going forward. I chose return on investment rather than return on equity since the former is more balance-sheet neutral. A company with lackluster returns on investment could boost return on equity simply by using more borrowed capital. That's a perfectly legitimate thing to do. But in an atmosphere of financial crisis, I'd rather tilt instead to companies that owe their profit performance to the strength of the plain-vanilla business operations as opposed to the aggressiveness or creativity of a CFO.

Given the un-exotic nature of the rules used here, the screen often identifies more stocks than the average investor is willing to hold in a portfolio. So I decided to narrow the list to 10 by selecting those companies that rank highest in terms of net cash (cash minus total debt) per share divided by share price. This recalls the kinds of rules I used in other deep-bargain screens. But this is only for a final narrowing-down in a list composed of performance basics.

That is what we'd hope to see this time around. There's no guarantee it will happen. The nature of the two bear markets is not identical (the 2008 collapse reflected a widespread asset allocation move, liquidation by many of equity holdings; earlier this decade, much of what occurred stemmed from deflation of formerly over-hyped tech-related stocks). But such distinctions are inherent in the backtesting process. No two periods are ever identical, so we need to make reasonable assumptions about whether the differences are likely to be relevant to future stock performance. In this case, I think not. I see no reason to doubt that once stocks move upward, investors will again favor shares of companies with track records of consistently superior fundamental performance.

The stocks:

With some other screens in this series, I discussed considerations relating to fundamental over-ride; situations where I would or might be inclined to let my judgment take precedence over the screen and drop some stocks that pass the strictly-numeric tests. Here, I have no such temptation.

The rules I articulated are pretty much good for all seasons. Admittedly, in normal times, better models can be created as I tune the rules more tightly to hunt harder for good stocks that may not be fully appreciated by the market. But as noted above, in the current climate, where the baby has been thrown out with the bathwater, we can keep it simple. This approach isn't leading me toward any major company-specific abyss (as would be the case, for instance, if I required cash hoards that are huge relative to the share price, something we don't usually see unless there are problems), so I see no reason to over-rule the screen.

The top 10 stocks that currently appear in this screen based on the ratio of net cash to price per share (regardless of how high or low these ratios actually are).

Companies / Industry

Apple Inc. (AAPL)
Computer Hardware

VAALCO Energy, Inc. (EGY) - Dave's Pick
Oil & Gas Operations

Dolby Laboratories, Inc. (DLB)
Communications Equipment

Stryker Corporation (SYK) - Paul's pick
Medical Equipment & Supplies

PetMed Express, Inc. (PETS)
Retail (Drugs)

Cognizant Technology Solution (CTSH)
Software & Programming

II-VI, Inc. (IIVI)
Scientific & Technical Instr.

Royal Gold, Inc. (RGLD)
Gold & Silver

Sun Hydraulics Corporation (SNHY) - Paul's holding
Misc. Fabricated Products

Aeropostale, Inc. (ARO)
Retail (Apparel)

Stocks Discussed: EGY, SYK, SNHY,
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