I was screening the U.S. stock market to look for those stocks that meet the “my-four step test for value” described by Charles Brandes – Benjamin Graham value investing school’s disciple and founder of Brandes Investment Partners in 1974 - in his book, “Value Investing Today,”
Brandes Investment Partners is a San Diego-headquartered investment advisory company that manages assets for institutional and private clients all of the world using different strategies when investing in stocks and fixed-income assets while following the value investing approach.
The U.S. investment advisory company has about $29.7 billion under management for a broad range of clients globally, as of June 30.
According to Brandes’ “four step test for value,” the financier prefers stocks that meet the following criteria:
- No losses within the past five years.
- Total debt is less than 100 percent of tangible equity.
- Share price is less than book value per share.
- Earnings yield is at least twice the yield on long term 20-year bonds.
In screening for value stocks, I have applied the aforementioned criteria with some modifications. I searched for stocks that have a price-book ratio is between zero and 1, debt to equity ratio which is less than 1, price-earnings ratio which is between 0 and 15, five-year average net profit margin greater than zero and five-year average gross profit margin greater than zero and last 12 months EPS from continuing operations greater than zero.
I have changed the tangible equity item to equity item in the ratio highlighted in criterion No. 2, therefore requiring a total debt to equity ratio of less than 1. This is also the first of the four tests for safety by Brandes.
Concerning criterion No. 4 - earnings yield is at least twice the yield on long-term 20-year bonds – I searched for stocks with earnings yields more than double the 20-Year high quality market (HQM) corporate bond spot rate. The yield of 4.3% on the 20-Year HGM corporate bond used as benchmark for my stock screening, has been computed as an average of the last 12 months’ spot rates.
According to the Federal Reserve Bank of Saint Louis, “the HQM yield curve uses data from a set of high quality corporate bonds rated AAA, AA or A that accurately represent the high-quality corporate bond market.”
In my stock screening, I have chosen those with a market capitalization of more than $3 billion, that are paying a dividend to their shareholders and the dividend yield – according to the most recent share price – is higher than the S&P 500 current yield of 1.89%.
The only stock that passes my stock screening is Honda Motor Co. Ltd. (HMC, Financial), a company that doesn’t need any presentation.
What would make me be in favor of this Japanese worldwide producer of motorcycles and automobiles if I were an investor, is the estimate on its sales for the next five-year period. Honda Motor’s sales - according to analysts - are going to rise at an annual average rate of 22.90%.
Sales means cash and, currently from its operations, the Japanese multinational motorcycles and car manufacturer can generate something like $8.20 to $8.50 billion of which a sizeable 35-40% can be used by the company for business growth purposes and to pay dividends to its shareholders.
The stock is currently trading at $29.34 per share on the New York Stock Exchange and with a total value of $52.27 billion in market capitalization. Honda Motor is trading only a few U.S. dollars above its 52-week low of $27.05 while its 52-week high is $32.17. And with an average target price per share – as forecasted by analysts – of $32.20, there are more upsides in the market value of Honda to come during the next trading months.
One of the catalysts to the market value of this stock for the coming months may be the Indian economy which is set to boost after the first nationwide Goods and Services Tax – GST – has replaced the complicated system of taxes starting July 2017. The new and simplified system of taxes should work as a propeller to the economy in India as it will promote the consumption demand. Increase in sales from India will be a key driver to the company’s Asian segment, which accounts for approximately 65% of Honda Motor’s total revenue.
Honda Motor doesn’t meet some of the criteria from the Brandes (Trades, Portfolio)’ test for safety such as “current assets are twice liabilities” and “total debt is less than twice net current assets.”
However, we must say that with a current ratio of 1.22, which is in line with its industry, Honda Motor has more than enough short-term financial resources to meet its short-term obligations. Furthermore, concerning the second test, as of today it is almost impossible to find good stocks which total debt is less than twice the net current assets. If you can find one stock that meets the just mentioned criteria, 99% of the cases you will end up with one of those Chinese stocks that have been labelled as a scam by the financial community years ago, since they brought bitter tears to many investors’ eyes.
GuruFocus gives Honda Motor a financial strength rating of 6 out of 10.
Disclosure: I have no position in any stock mentioned in this article.
