You have 4 free articles remaining. Subscribe
Jan 1, 2016

Three Stingy Stocks For 2016

by Norm Rothery

Norm RotheryThe Stingy Stock list got its start in Canadian MoneySaver way back in 2001. The idea was (and still is) to try to beat the S&P 500 by picking value stocks from within the index itself using a simple numbers-based approach.

I'm pleased to say that the Stingy Stocks have gained an average of 13.9% per year since 2001. By way of comparison, the S&P500 (as represented by the SPY ETF) climbed 6.4% per year over the same period. The Stingy Stocks beat the index by an average of 7.5 percentage points annually. You can examine the full performance record in Table 1.

The long-term numbers are excellent, but they come with ups and downs along the way. For instance, last year wasn't great. The Stingy Stocks lost 1.4% while the S&P500 (SPY) advanced 5.4%. That's a poor relative showing, but such slumps have to be expected on occasion.

How are the Stingy Stocks selected? I look for companies that are both cheapand relatively safe.Norm Rothery

On the value front, I like stocks trading at price-to-sales ratios of less than one. Typically only a few stocks pass the test and this year was no exception.

Cheap stocks are great but I also want some assurance they won’t go bust. That's why I start with firms in the S&P 500, which tend to be large and relatively stable.

But because size is an insufficient measure of safety, I also look for companies with little debt and lots of assets. Such firms are stronger than companies perched precariously on mountains of debt.

Three ratios are useful when looking for companies with little debt. Perhaps the most important is the debt-to-equity ratio, which is calculated by dividing a company’s debt by its shareholders' equity. The amount of debt that a company can comfortably support varies from industry to industry but debt-to-equity ratios of more than 1 can be too high. I prefer very conservative companies with debt-to-equity ratios of 0.5 or less.

Norm RotheryThe next balance sheet figure to consider is the current ratio which is calculated by dividing a company’s current assets by its current liabilities. Current assets are assets (such as receivables and inventory) that can be turned into cash within the next year. Current liabilities are payments that a company must make over the next year. Naturally, an investor would like a company’s current assets to be much more than its current liabilities, and I prefer conservative companies with current assets at least twice as large as current liabilities. After all, you can be pretty sure that a firm’s creditors will demand prompt payment of the current liabilities. On the other hand, some current assets, such as inventory, might not turn out to be worth as much as expected.

Finally, a company’s earnings before interest and taxes should be large in comparison to its interest payments. The ratio of earnings-before-interest and taxes-to-interest-payments is called interest coverage and I like this ratio to be at least two or more.

Norm Rothery

While the debt ratios I’ve selected are useful in determining a firm’s ability to shoulder debt, they are not perfect. For instance, some long-term obligations may not be fully reflected on a company’s balance sheet and are, sensibly enough, called off-balance sheet debts. Regrettably, off-balance sheet debt can be a source of considerable consternation. Things like unexpected legal liabilities can sideswipe what might otherwise be a good investment. That’s why, as with all screening techniques, you should embark on a more detailed investigation of each stock before making a final investment decision.

Continuing the safety theme, I also want a company to show some earnings and cash flow from operations over the last year. After all, a business isn't likely to go bust when it is profitable and has cash coming in the door.

That’s a daunting list of requirements and I’ve summarized the primary factors in Table 2.

This year the method uncovered only three stocks. They're shown in Table 3 where you can look up each stock's dividend yield and multiple of sales (P/S), earnings (P/E), and cash flow (P/CF).

I hasten to add that it's a good idea to own more than three stocks. I do. Most investors should have 20, or more, and even aggressive investors should own more than ten.

I hope the method piques your interest. But be sure to fully investigate each stock fully before investing.

Norman Rothery, PhD, CFA, Founder of StingyInvestor.com, Toronto, ON (416) 243-9580, rothery@stingyinvestor.com, www.stingyinvestor.com