I am a big fan of stock screens. They can quickly identify stocks with the characteristics that I prefer and eliminate those that don't. A screen, however, is simply a means to an end and is certainly not a substitute for research. In fact, if you do not take the time to conduct further research, such as reading the company's earnings press release and its 10-K (an annual filing required by the SEC), you could expose your portfolio to more risk than you realize.
A stock I looked at last weekend shows why.
Oil-Dri Corporation (ODC) showed up in the results of my value screening strategy. (The strategy is highlighted in the July AAII Journal First Cut column.) ODC trades at a price-earnings ratio of 17.0 and a price-to-book ratio of 1.7. Revenues have consecutively increased every year between 2003 and 2009. Net income and earnings per share have been almost as good, except for a dip in 2006. Margins have expanded in recent years and cash flows from operations have been positive for several years. ODC topped fiscal third-quarter expectations by three cents and profit projections for both fiscal 2010 and fiscal 2011 have been revised higher.
The company makes sorbent products, such as cat litter. Leaving all jokes about stinky investments aside, it does not take a cat owner to realize that there will always be demand for cat litter. (For the record, I am a dog person.)
These characteristics are good, but after I spent a little time reading ODC's latest quarterly earnings release and its 10-K filing, I found some red flags.
Revenues for the fiscal third-quarter fell by 3% on a year-over-year basis. CEO Daniel Jaffee noted that business from Wal-Mart (WMT) declined. This would not be a big issue if the discount chain wasn't responsible for 26% of ODC's fiscal 2009 revenues. Worse yet, during the past three years, sales to WMT accounted for an increasingly larger proportion of Oil-Dri's total sales.
Then there is the agricultural side of the business. Oil-Dri provides products related to crop protection, and sales declined last quarter "due to a continued decline in this market." The 10-K states that the increased use of genetically enhanced agricultural products is reducing demand for the company's products.
Finally, ODC is a "controlled company." This is an exemption granted by the NYSE that allows, among other things, for the company not to have to have the majority of its board of directors comprised of independent directors. The voices of individual shareholders are further quieted by the fact that the father-son team of Chairman Richard Jaffee and CEO Daniel Jaffee has effective control over all shareholder votes. In other words, individual investors lack adequate representation.
None of this is to say that Oil-Dri is a bad investment choice, but considering the stock jumped by nearly 46% year-to-date, investors should pause to think how comfortable they are with the company's risks going forward.
The bigger point is not whether ODC is a good investment, but rather that it shows how a stock screen is limited by its inputs. A stock screen is merely a quantitative filter designed to generate a list of stocks. It cannot reveal important qualitative factors such as whether a company's board of directors is independent or if orders from the largest customer have been reduced. Therefore, it is important that investors use screens as merely as the starting point in the research process.
THE WEEK AHEAD
Approximately 150 S&P 500 companies are scheduled to release second-quarter profit results next week. Among them will be Dow Jones industrial average components: E.I. du Pont (DD - Tuesday), Boeing (BA - Wednesday), Chevron (CVX - Friday), and Merck & Co. (MRK - Friday).
June new home sales lead off the week's economic calendar on Monday. Keep in mind that, unlike the existing home numbers (released this morning), the new home data will reflect sales contracts signed after the expiration of the home buyer's tax credit.
The week's most anticipated economic report will be released on Friday: second-quarter GDP. Marketwatch.com lists the consensus forecast as calling for growth of 2.5%.
Other reports on the economic calendar include the Conference Board's July consumer confidence survey (Tuesday), May S&P/Case-Schiller home price index (Tuesday), June durable goods orders (Wednesday), the Federal Reserve's Beige Book (Wednesday), the final University of Michigan consumer confidence survey (Friday), and the July Chicago Purchasing Managers Index (Friday).
The Treasury Department will auction $38 billion of two-year notes on Tuesday, $37 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.
No Federal Reserve officials are currently scheduled to make public appearances.
Charles Rotblut, CFA is a Vice President with AAII and editor of the AAII Journal.