One of the biggest challenges in investing is trying to balance consistency to one'sinvestment philosophy with the fact that markets are quite dynamic. I have been very successful in adapting to the post-crash environment by focusing on balance sheets, cashflow generation, and down-side risk. As the market appears to be moving beyond recovery from the trauma of 2008-2009 to renewed growth (witness the number of stocks that have moved to all-time highs in the past few months), I fear that I need to recalibrate my own process somewhat. That is not to say it is time to quit focusing on the attributes I cited, but rather perhaps we need to remember that stocks are call options on the future of a company.
I spent the past few years finding decent companies at what I thought were fantastic valuations. Now, I wonder if it is time to focus a bit more on fantastic companies at decent valuations. I shared Intuitive Surgical (ISRG) recently as a good example.
In 2007, I offered my thinking on a class of stocks I called Small-Cap "Rockets" and actually began publishing a monthly report. Here is an example. These were essentially companies that weren't widely followed but that had high ROIC and good price momentum over longer periods of time. Over the years that have passed, many of the companies identified through these screens were acquired, some quite recently. In retrospect, I probably should have been less tolerant of companies that used significant debt to fund their growth, as many of these companies remain well below the prices they attained in 2007.
In any event, with an eye on trying to open my mind up to more opportunities at the 20 PE level among high return on capital growth companies that aren't widely followed, I have tweaked the old screen as follows:
- Market Cap > $200mm
- ROIC > 14%
- Net Debt to Cap < 25%
- Maximum # of Analysts: 5
- Estimates for Next Year: 3 Month Change > -4%
- Revenue growth (ttm) > 10%
- EPS growth (ttm) > 16%
- Price Change 12 Months: > S&P 500
- Price Change 3 Months: > S&P 500 + 6%
To be clear, this is a momentum screen. We are trying to capture growth companies (hence the earnings and sales requirements) where the stock market sees no problem (outperforming over past 3 months, at least in line over past year). Also, the outlook isn't deteriorating. The companies aren't burdened with debt and use their capital efficiently.
When I ran the screen, I ended up with 11 companies that met all of the criteria:
Well, there is no doubt that price momentum is well entrenched in this group (average one-year return is 79%), as the only stock up less than 30% in the past year is NIC (EGOV), which has been more of a market performer. It, along with Raven Industries (RAVN), has been on my watchlist, and both are owned by a client. That same client also owns Balchem (BCPC), so I am quite familiar with that company as well.
What makes the list interesting to me is that it is pretty diversified, with representatives from 5 of the 10 economic sectors. Not surprisingly, the typical PE is around 20X, but many of these companies have at least near-term growth that is substantially higher than the typical company. I didn't include it in the table above, but the analysts give the group an average 15% LT growth rate.
I had heard of Pricesmart (PSMT) and Boston Beer (SAM), both in the Consumer Staples sector, and the rocket has certainly launched in both cases. I am not that familiar with either. SAM has taken out its former all-time high, while PSMT is flirting with its previous high set a decade ago.
I am not familiar with any of the Financials. BGCPartners (BGCP) was formerly e-Speed, which I remember as a Motley Fool Hidden Gem that never panned out. Eagle Bancorp (EGBN) looks quite interesting. Based in Bethesda, MD, the bank trades at a reasonable 1.5X Tangible Book Value and is rapidly approaching its former all-time high from 2006. They cut their dividend in 2008. Erie Indemnity (ERIE), on the other hand, did not, and it yields a decent 3.1%. Its price and its valuation are both at all-time highs. In any event, while none of these Financials is burdened by "debt", they all have substantial liabilities.
RAVN, the lone Industrial, is a neat company. I happened to visit them in South Dakota this summer and have followed them closely for years. The valuation is quite reasonable, but their near-term growth may be challenged due to most of their businesses operating at unsustainable margins. Most investors are interested in their precision agriculture products. I have a close eye on this one, especially as it breaks to a new all-time high.
Four Technology companies made the cut. I happened to visit EGOV this summer as well at their HQ in Kansas City. The company has a fantastic business model that enables states to create portals at no up-front cost. Our visit helped my client retain confidence in their investment this summer, and the name looks attractive to me at this point. I don't know Hittite Microwave (HITT), Interdigital (IDCC) or Travelzoo (TZOO) very well.
Balchem (BCPC) sells specialized gases as well as choline chloride. The company has tremendous pricing power, apparently, but it has chosen smartly to grow its markets. The valuation has always seemed high to me.
So, while I haven't exactly positioned my Top 20 Model Portfolio with momentum growth stocks, I am beginning to think that I don't want to overplay my value tilt to which I have been committed the past few years. Dusting off my old "Rocket" screen and tweaking it will hopefully keep me focused. Today's list is a start.
Disclosure: No positions in any stock mentioned