4 Consumer Cyclical Stocks That Fit Graham's Lost Formula

These companies may offer good value in June

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Jun 03, 2022
Summary
  • Prior to his death, Benjamin Graham developed a formula based on the price-earnings and equity-to-asset ratios.
  • Three homebuilders and a flooring company qualify for the screener among S&P 500 companies.
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On the back of a stronger-than-expected jobs report for May and rising interest rates, U.S. market indexes declined on Friday.

The Bureau of Labor Statistics reported that hiring remained elevated last month, with nonfarm payrolls adding 390,000 jobs. This was higher than the 328,000 jobs economists were anticipating.

On Friday morning, the Dow Jones Industrial Average was down 0.6%, while the S&P 500 Index decreased 1.1% and the Nasdaq Composite fell 1.6%.

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In regard to individual sectors, consumer cyclical stocks were also down, having fallen 1.36% for the day. Year to date, the sector is down 23.84% as the economy continues to contend with supply chain shortages and higher costs of production.

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As a result of these developments, investors may be interested in consumer cyclical companies that qualify for Benjamin Graham’s Lost Formula screen, a Premium GuruFocus feature.

Prior to his death in 1976, the author of "Security Analysis" and "The Intelligent Investor" developed a refined formula that screened for companies with a price-earnings ratio of less than 10 and an equity-to-asset ratio of at least 0.5. The formula got its name from that fact that he was unable to publish it before his passing; therefore, it was lost from public knowledge for a time. Since Graham also prioritized a minimum interest coverage of 5 with the companies he invested in, that element was included in the criteria as well.

A backtest of the strategy from 1926 to 1976 showed it would have outperformed the Dow benchmark by approximately twice as much.

The screener found that as of June 3, S&P 500 companies in the consumer cyclical space that met these criteria were D.R. Horton Inc. (

DHI, Financial), Lennar Corp. (LEN, Financial), PulteGroup Inc. (PHM, Financial) and Mohawk Industries Inc. (MHK, Financial).

D.R. Horton

D.R. Horton (

DHI, Financial) has a $26.93 billion market cap; its shares were trading around $76.40 on Friday with a price-earnings ratio of 5.48, a price-book ratio of 1.61, a price-sales ratio of 0.9 and an equity-to-asset ratio of 0.63.

The Arlington, Texas-based home construction company operates in 98 markets across 31 states in the U.S. It also offers homebuyers mortgage financing and title agency services through its financial segment.

The GF Value Line suggests the stock, while undervalued, is a possible value trap currently based on historical ratios, past performance and future earnings projections. As such, potential investors should do thorough research before making a decision.

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GuruFocus rated D.R. Horton’s financial strength 7 out of 10. Although the company has issued new long-term debt over the past three years, it is at a manageable level due to adequate interest coverage. The robust Altman Z-Score of 5.51 also indicates it is in good standing. The return on invested capital overshadows the weighted average cost of capital, meaning value is being created as the company grows.

The company’s profitability scored a 10 out of 10 rating, boosted by operating margin expansion, returns on equity, assets and capital that outperform a majority of competitors and a high Piotroski F-Score of 7 out of 9, which implies business conditions are healthy. Consistent earnings and revenue growth contributed to a predictability rank of four out of five stars. According to GuruFocus research, companies with this rank return an average of 9.8% annually over a 10-year period.

Of the gurus invested in D.R. Horton,

George Soros (Trades, Portfolio) has the largest stake with 0.86% of its outstanding shares. The Smead Value Fund (Trades, Portfolio), Glenn Greenberg (Trades, Portfolio), the Parnassus Endeavor Fund (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and several other gurus also own the stock.

Lennar

Lennar (

LEN, Financial) has a market cap of $23.25 billion; its shares were trading around $80.29 on Friday with a price-earnings ratio of 6.29, a price-book ratio of 1.15, a price-sales ratio of 0.87 and an equity-to-asset ratio of 0.63.

The homebuilder, which is headquartered in Miami, primarily caters to first-time, move-up and active adult homebuyers, but is also involved in multifamily construction. It also offers mortgage financing and related services.

According to the GF Value Line, the stock is modestly undervalued currently.

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Lennar’s financial strength was rated 6 out of 10 by GuruFocus. While assets are building up at a faster rate than revenue is growing, the Altman Z-Score of 4.07 indicates the company is in good standing. The ROIC also eclipses the WACC, indicating good value creation is occurring.

The company’s profitability fared even better with a 9 out of 10 rating, driven by expanding margins, strong returns that outperform industry peers, a high Piotroski F-Score of 7 and a 3.5-star predictability rank as revenue and earnings growth has been steady. GuruFocus data shows companies with this rank return an average of 10.6% annually.

With a 0.64% stake, the

Smead Value Fund (Trades, Portfolio) is the company’s largest guru shareholder. Other guru investors of Lennar include Jim Simons (Trades, Portfolio)’ Renaissance Technologies, Fisher, Greenberg, Grantham, Dalio, Steven Cohen (Trades, Portfolio), Ron Baron (Trades, Portfolio), Ronald Muhlenkamp (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).

PulteGroup

PulteGroup (

PHM, Financial) has a $10.74 billion market cap; its shares were trading around $45.20 on Friday with a price-earnings ratio of 5.54, a price-book ratio of 1.45, a price-sales ratio of 0.81 and an equity-to-asset ratio of 0.56.

The Atlanta-based home construction company operates in 40 U.S. markets across 23 states. It mainly builds single-family detached homes for entry-level, move-up and active adult buyers. It also offers mortgage financing and title agency services through its financial arm.

Based on the GF Value Line, the stock appears to be modestly undervalued currently.

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GuruFocus rated PulteGroup’s financial strength 8 out of 10, driven by a comfortable level of interest coverage and a high Altman Z-Score of 4.11. The ROIC also exceeds the WACC, so value is being created.

The company’s profitability fared even better, scoring a 9 out of 10 rating. In addition to an expanding operating margin, PulteGroup has strong returns that outperform a majority of competitors and a high Piotroski F-Score of 7. It also has a one-star predictability rank. GuruFocus says companies with this rank return, on average, 1.1% annually.

Bill Nygren (Trades, Portfolio) has the largest stake in PulteGroup with 1.77% of its outstanding shares. Grantham, Chuck Royce (Trades, Portfolio) and Dalio also have positions in the stock.

Mohawk Industries

Mohawk Industries (

MHK, Financial) has a market cap of $8.85 billion; its shares were trading around $139.79 on Friday with a price-earnings ratio of 9.07, a price-book ratio of 1.08, a price-sales ratio of 0.82 and an equity-to-asset ratio of 0.58.

Headquartered in Calhoun, Georgia, the company manufactures flooring products, including carpets, ceramic tile, laminate and wood, for residential and commercial applications.

The GF Value Line suggests the stock is modestly undervalued currently.

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Mohawk’s financial strength was rated 7 out of 10 by GuruFocus on the back of a comfortable level of interest coverage. The Altman Z-Score of 2.87, though, indicates it is under some pressure. The ROIC also surpasses the WACC, so value creation is occurring.

The company’s profitability scored an 8 out of 10 rating. Even though the operating margin is in decline, returns outperform over half of its industry peers. Mohawk also has a high Piotroski F-Score of 8 and a one-star predictability rank.

With a 2.76% stake,

Richard Pzena (Trades, Portfolio) is Mohawk’s largest guru shareholder. Other gurus who are invested in the stock include John Rogers (Trades, Portfolio), Charles Brandes (Trades, Portfolio), Simons’ firm, Grantham, Robert Olstein (Trades, Portfolio), Dalio, Joel Greenblatt (Trades, Portfolio), Jones, Ruane Cunniff (Trades, Portfolio) and Caxton Associates (Trades, Portfolio).

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I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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