Let’s turn the dial up a notch.
High profitability and low debt are qualities I often look for in stocks. Today I will highlight a few companies that take these desirable traits to an extreme.
These companies earned a return on stockholders’ equity of 25% or better in their latest fiscal year. And their debt is quite modest, no more than 10% of stockholders’ equity.
Out of some 3,300 U.S.-traded stocks with a market value of $250 million or more, only 29 meet those stiff criteria. I can’t recommend most of them because they are expensive stocks; their merits are well known. But I will recommend four of them today.
IDT
We’ll start with IDT Corp. (IDT, Financial), an eccentric telecommunications company out of Newark, New Jersey. Among its specialties are programs to facilitate cheap international calls, and cybersecurity consulting.
In May, the Wall Street Journal described the company’s plans to open a “cybersecurity Yeshiva,” combining Jewish studies and the study of computer security. Several of IDT’s top officials are orthodox Jews, and CEO Howard Jonas has helped to fund several orthodox Jewish causes.
I think investors are often uncomfortable when a corporate executive is openly and actively religious, no matter what religion he or she espouses. And I believe that’s one reason IDT shares sell for only five times recent earnings.
Last year IDT earned $18.8 million on sales of $1.65 billion, and posted a return on equity of more than 60%. Debt is only about 4% of equity.
NewLink Genetics
Next, I call your attention to NewLink Genetics Corp. (NLNK, Financial), which I also mentioned in a May column on stocks that have doubled.
NewLink, a small biotech company based in Ames, Iowa, has debt less than 1% of equity and earned more than 70% on equity in its latest fiscal year. The latter figure is unsustainable, but I find the company interesting.
NewLink is working on a drug for pancreatic cancer, called HyperAcute. The drug, as yet unproven, is in Phase III clinical trials. The company is also working on drugs to treat other forms of cancer.
Fledgling biotech companies like NewLink have very lumpy and unpredictable revenue. They will get a big contract or payment from a large drug company from time to time, then go months or years without one.
Analysts expect NewLink to lose money this year and next, yet three of the five analysts who cover it recommend it.
Taro
Taro Pharmaceutical Industries Ltd. (TARO, Financial) is an Israeli company that trades on the New York Stock Exchange. It specializes in dermatological products, especially topical creams and ointments, but also makes a variety of other drugs and health-care products.
Last fiscal year Taro notched a return on equity of more than 39%, which is highly commendable. The company’s debt is less than 1% of equity.
The stock was long depressed by a debilitating takeover battle with Sun Pharmaceuticals of India, but that epic slugfest now appears to be over, with Taro retaining independence.
Sanderson Farms
Finally, I recommend an old favorite of mine, chicken producer Sanderson Farms Inc. (SAFM, Financial). Chicken has been gaining market share at the expense of beef, and that trend has accelerated in the past decade. In 2014 for the first time, more pounds of chicken were eaten in the U.S. than beef.
The stock is currently cheap (six times earnings), partly because bird flu is affecting chicken producers’ flocks and raising costs. I regard that as a real but temporary problem, the kind of problem I like to use as a buying opportunity.
Track Record
This is the 11th columns I’ve written on stocks with high profitability and low debt. The previous 10 appeared in 2000 through 2004 and 2010 through 2014.
On average, my selections in this series have achieved a one-year return including dividends of 15.1%, compared to 7.5% for the Standard & Poor’s 500 Index. Seven of the 10 columns were profitable, and seven beat the S&P 500.
The bad news is that the three columns that failed to beat the S&P were the three most recent ones, from 2012-2014. The latest, from a year ago, was a clunker with a 19.6% loss. The biggest problem: a 79.3% loss in LeapFrog Enterprises Inc. (LF), a maker of education games and software.
Bear in mind that the results of my column picks are hypothetical and don’t reflect actual trades, trading costs, or taxes. Past performance doesn’t necessarily predict future results. And the performance of my column picks shouldn’t be confused with that of actual portfolios I manage for clients.
