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Sometime a go I shared a formula in a Seeking Alpha article that I have used since the mid 1990s as an initial valuation screen on stocks of interest.

So, now is time to test that little formula in a real world test.

Below is a list of five stocks that were initially screened out of the S&P 500 as financially sound companies. The only criteria to select these candidate stocks is that they pass the formula screening by a large margin. There are many more stocks that pass this screening, but for the sake of simplicity I've kept the number down to five.

The formula requires Sales, Sales Growth, Net Profit Margin, and Shares Issued as inputs. For the sake of this article I've included an indicator of safety in the form of ratio of Current Assets to Total Liabilities.

I would be reasonably comfortable owning these shares knowing nothing but the information in the table. If I were to make a large commitment to these investments I would read a couple of years of 10Ks and probably a year's worth of Seeking Alpha articles and any other due diligence that occurred to me.

Here we are just going to test whether the simple use of this formula can pick a majority of winners over the short and medium term.

CH Robinson Worldwide (CHRW)

Transportation sector. C.H. Robinson Worldwide, Inc., a third-party logistics company, provides freight transportation services and logistics solutions to companies in various industries worldwide. It also engages in buying, selling, and marketing fresh produce. Yield: 2.5%

National Oilwell Varco (NOV)

Energy upstream sector. National Oilwell Varco, Inc. provides equipment and components for oil and gas drilling and production. Its Rig Technology segment offers offshore and onshore drilling rigs. The company is involved in virtually all products and services in support of the oil patch worldwide. NIV should be a prime beneficiary of the expansion of shale and horizontal drilling worldwide. Yield 0.8%

CVR Energy, Inc. (CVI)

Energy and Chemical segment. CVR Energy, Inc., through its subsidiaries, engages in petroleum refining and nitrogen fertilizer manufacturing. The company operates a coking medium-sour crude oil refinery in Coffeyville, Kansas and Wynnewood, Oklahoma; and a crude oil gathering system serving Kansas, Nebraska, Oklahoma, Missouri, and Texas. It also owns a proprietary pipeline system that transports crude oil from Caney, Kansas to its refinery. The Nitrogen Fertilizer segment operates a nitrogen fertilizer plant in North America that utilizes a pet coke gasification process to produce nitrogen fertilizer. Yield: 5.1%

WellCare Health Plans (WCG)

Healthcare segment. WellCare Health Plans, Inc. provides managed care services for government-sponsored health care programs in the United States. The company should be a significant beneficiary of the Patient Protection and Affordable Care Act (Obamacare).

Deltek US Holdings (DK)

Energy, midstream, downstream. Delek US Holdings, Inc. operates as an integrated downstream energy company that operates in petroleum refining, logistics, and convenience store retailing businesses. The company owns 400 miles of crude oil transportation pipelines, 123 miles of refined product pipelines, 600-mile crude oil gathering system, and associated crude oil storage tanks with an aggregate of approximately 2.6 million barrels of active shell capacity. The company should benefit from the trend toward US energy independence without the exposure of exploration and production companies. Yield: 1.7%

 

 

SymbolPriceSalesRev GrowthNet Pro mgnSharesCA/TLTarget Price
CHRW$56.07$11.8B17.3%5%161 Mil1.29$85.60
NOV$67.65$21.04B23.4%11.34%427 Mil1.15$143
CVI$58.20$8.95B19.5%6.3686.6 Mil1.03$173
WCG$56.96$7.87B26%1.97%43.46 Mil1.42$94.58
DK$34.41$8.88B7.1%3.42%58.83 Mil0.88$90.85

The point of this experiment is to determine, in a public venue, whether this formula is able to select winning stocks and de-select losing stocks.

The formula reduces an enterprise to a Black Box earnings generator. The stream of earning (net profit margin) should be directly and proportionately related to the value of the enterprise. The rate of growth of the earnings stream (revenue growth rate) should be related, in a more complex function, to the value of the enterprise.

The concept is that if the company makes buggy whips its growth will be negative and be de-selected by the formula. If the company is losing money it will, likewise, be de-selected by the formula.

There are stories associated with the above companies, but, for the purposes of this experiment, the story is assumed to be less important that the numbers that appear to make the Black Box underpriced for current conditions.

The formula has some of the characteristics of a PEG ratio except the "G" is in revenue rather than earnings. This is due to my conviction that, in general, sales must grow in order for earnings to grow.

The assumptions are:

Equal amount invested in each

Sell at a 15% decline.

Let the fun begin.

Source: Test Of Formula Investing

Additional disclosure: I will buy some of each of these stocks today.