Buy, Sell, or Hold
Add Fundamentals to Your Growth Approach
A Few Suggestions ---
The last couple of days in the stock market have been downright ugly. The Standard & Poor’s 500 Index has dropped 6.0% during the three days ending Friday, August 21. From the S&P 500’s intraday (within the day) peak of 2,134.72 set on May 20, 2015, the Index is now down 7.7%.
The good news is: The U.S. stock market is oversold on a short-term basis which means the market has dropped too fast in only three days. We should see a rally within the next couple of days. A rally could present an opportunity for you to readjust your portfolio to meet your level of comfortable risk and your long-term investment objectives. A falling stock market is not the time to sell everything, nor is it the time to freeze up and take no action to protect your 401-k and other investments.
I am comfortable selling my moderate risk stocks when the stock market becomes overvalued, and repurchasing those moderate risk stocks when the stock market drops and becomes undervalued. On December 1, 2013, I instructed my subscribers to reduce risk in their portfolios, because the Dow Jones Industrial Average had just eclipsed 16,000. All subscribers were instructed to invest 60% to 65% of their funds in very low risk stocks, ETFs, and cash and invest the remainder of their portfolio in low- to moderate-risk stocks.
During the 21 months from December 1, 2013 through July 28, 2015, the Dow increased 6.4% compared to my conservative allocation model’s advance of 5.2%. However, since July 28, my 16-stock model is down only 0.1% compared to the Dow’s decline of 6.6%!
Buy, Sell, or Hold
My value methodology is about to flash an intermediate buy signal. If the Dow drops to 16,351 or below from the current 16,460, I will change the allocation in my model to 50% in very low risk stocks, ETFs, and cash and 50% in moderate risk stocks. I will be a buyer rather than a seller in this weak stock market. I am hoping the stock market will drop somewhat lower, so that I can aggressively buy a few stocks at bargain prices. You can easily see why my return has been 15% per year during the past 12 plus years while I have been writing the Cabot Benjamin Graham Value Investor. And that 15% doesn’t even include dividends!
My value approach seems contrary to the thinking of most investors, but I believe selling when the market is high and buying when the market is low makes sense. Warren Buffett has been using this system very successfully for decades. The alternative is chart reading, which seems to lead me into selling late and buying late – and there are all those costly whipsaws which totally frustrate me.
Four Ratios and Ratings to Increase Your Returns
Ten days ago, I gave a presentation at the Cabot Investors Conference in which I included a few tips on how you can enhance your returns by adding a simple element to your stock picking process. Whether you use charts, use price and earnings momentum, use a value approach, or throw darts, I maintain that you should, at the very least, become aware if your stock choice is undervalued or overvalued.
If you are picking a stock that is overvalued, you should keep it on a short leash and sell when the hint of trouble lies ahead. On the other hand, if your choice is undervalued, you could ride out the bumps in the road until the stock price reaches your objective.
Any of the following ratios and ratings will provide you with an indication of your stock’s overvalue/undervalue status. In my opinion, you can easily increase your investment returns if you pay attention to at least one of the following value criteria.
Low PEG Ratio – is an excellent measure to use when choosing a growth stock. If the current price to earnings ratio (P/E) is less than the forecast growth rate of earnings, your growth stock is undervalued. I calculate PEG ratios by dividing the current stock price by the last (trailing) four quarters of actual earnings per share (EPS). Then divide the resulting P/E by the forecast 5-year EPS growth rate. Stocks with PEG ratios below 1.50 are considered undervalued.
An excellent example of a moderate risk growth stock which is undervalued because of its low PEG ratio is Synchronoss Technologies (SNCR 43.20). Synchronoss is a mobile innovation company that allow customers to connect, synchronize and activate devices and services providing enterprises and consumers with the ability to work and play in a connected world.
Synchronoss is benefiting from the strong growth in the smartphone and tablet markets. Sales increased 35% and EPS surged 32% during the 12 months ended June 30, 2015. The company’s PEG ratio of 1.15 is attractive, the balance sheet is very solid, and sales and earnings are growing rapidly. SNCR will likely surge 53% to reach my Min Sell Price of 65.98 within 12 to 18 months. Buy at the current price.
Low Price to Book Value Ratio – is an effective yet easy ratio to calculate to determine if your stock choice is undervalued or overvalued. Simply divide the current stock price by the current book value per share. Most research services provide book value numbers for all companies. Book value represents the net assets of a company (total assets less liabilities). Price to book value ratios less than 2.00 indicates your stock is undervalued.
Allergan Corp. (AGN 298.88) provides a good example of a company with rapid sales and earnings growth selling at a low price to book value ratio. The company is a leading manufacturer of generic drugs. Allergan’s goal is to create difficult to produce off-patent drugs. Allergan (formerly Actavis) has grown rapidly in recent years by acquiring large companies within the pharmaceutical sector.
The Allergan/Actavis merger will create savings of $5.00 per share within the next 12 months. Sales will likely advance 28% and EPS will jump 21% to 19.20 in the 12 months ending June 30, 2016. AGN shares sell at just 1.76 times book value, which is very reasonable for a company in the healthcare sector. I expect AGN’s stock price to rise 26% to my Min Sell Price of 376.46 within one year. Buy AGN at the current price.
Low Price to Sales Ratio – is another easy to calculate ratio that provides an excellent indication of whether your stock choice is undervalued or overvalued. Divide the current stock price by the latest four quarters of sales per share (total sales divided by common shares outstanding). A price to sales ratios less than 1.00 provides a good indication that your stock is undervalued.
Penske Automotive Group (PAG 49.06)
possesses an ultra-low price to sales ratio, yet the company’s sales and earnings are set to accelerate during the next several quarters. Penske operates automotive and commercial truck dealerships, and distributes commercial vehicles, diesel and gas engines, power systems, and parts and services. Penske offers 40 different brands of vehicles in 180 automotive retail franchised dealerships in the U.S. and 148 franchises outside the U.S., primarily in the U.K.
The boom in car and pickup truck sales in the U.S. and the U.K. will likely continue during the next several years. PAG shares sell at just 0.25 times sales and 14.1 times current EPS with a dividend yield of 2.1%. The company’s board of directors has boosted the quarterly dividend every quarter for 18 consecutive quarters. I expect PAG’s stock price to advance 36% to my Min Sell Price of 66.81 within one year. Buy at the current price.
High S&P Value Rating
– is a simple yet reliable way to help you enhance the performance of your investments. Standard & Poor’s provides a Value Rating for more than 1,000 stocks. The rating is scaled from 1 to 5 with 5 indicating the most undervalued stocks. I prefer to invest in companies with S&P Value Ratings of 4 or 5. Most brokerages provide S&P ratings for free to investors.
LKQ Corp. (LKQ 29.47) currently has a Standard & Poor’s Value Rating of 5. The company is one of the largest providers of recycled automotive replacement parts with 100 sales and processing centers in North America and Europe. LKQ buys wrecked cars at auctions, salvages the reusable parts, and sells the parts to collision repair shops.
LKQ has established an enviable record of steady 20% sales and earnings growth during the past decade through its aggressive acquisition program. Sales will rise 10% and earnings per share are forecast to rise 15% during the next 12 months ending 6/30/16, but new acquisitions could drive sales and earnings higher.
Standard & Poor’s currently rates LKQ as highly undervalued with its best Value Rating of 5. At 21.4 times current EPS, LKQ shares are reasonable, the balance sheet is very strong, and growth is steady and rapid. I expect LKQ’s stock price to climb 31% to reach my Minimum Sell Price of 38.54 within one to two years. Buy LKQ at the current price.
I will continue to follow Synchronoss, Allergan, Penske, and LKQ, as well as many other undervalued, high-quality companies in my Cabot Benjamin Graham Value Investor.For more information on how to subscribe, click here.
Sincerely,
J. Royden Ward
Chief Analyst, Cabot Benjamin Graham Value Investor
