Week 75 - S&P 100 Companies without Red Flags

Situation: We all know that President Harry Truman preferred one-handed economists because he found the phrase “on the other hand” to be so exasperating. And, increasingly, the tables that accompany our blogs are sprinkled with red flags. So this week we’ll publish a Table that doesn’t look like it has the measles!

You’ve already heard that we favor large companies with multiple product lines ringing up sales. Why? Because that creates internal support, meaning that when sales crump in one line the company has the resources and talent needed to fill that hole. Anyone who has played on a good sports team or fought in a good military unit understands that concept. But stock traders don’t (or won’t) embrace it because the company then becomes too difficult to value “by the sum of its parts.” This means the stock’s price will lag behind its earnings growth. But you don’t care because you use a “buy and hold” investment strategy.

Accordingly, we’ve screened companies in the S&P 100 Index for the following traits (Table):
a) Dividend yield greater than or equal to 1.8%;
b) 10 yr annualized total return greater than or equal to 5%;
c) Losses during the Lehman Panic less than those for the S&P 500 Index;
d) Finance Value (b plus c) that beats the S&P 500 Index;
e) 5 yr annualized total return of at least 2.9% (i.e., the “risk-free” rate determined by averaging the interest rate of 10 yr US Treasury Notes over the past 5 yrs);
f) 5 yr dividend growth rate of at least 4%;
g) Return on Invested Capital (ROIC) of at least 10% over the trailing 12 months;
h) Long-term debt that is less than half the company’s total capitalization;
i) Last year’s free cash flow (FCF) is sufficient to fund this year’s dividends.

Our screen turned up 10 companies. Note that 6 of the 10 are from the Stockpickers Secret Fishing Hole (Week 29 & Week 68), which is the 65-stock Dow Jones Composite Index (DCA). Excluding regulated utilities (which have too much debt and too little free cash flow to pass our screen), there are 32 DCA companies in the S&P 100 Index. So the chance of a DCA company passing our screen is 19% (6 divided by 32) vs. 5.9% (4 divided by 68) for a non-DCA company.

Bottom Line: You can win by staying away from companies that are inefficient (low ROIC), have high LT debt, or pay dividends with retained earnings and borrowed money instead of using free cash flow. There is no bad news in our screen. If your portfolio contained these stocks throughout the past 10 yrs and you kept buying more during the Lehman Panic, then you’re a smart “vulture investor."

Risk Ranking: 6 (see Week 72).

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