About a year ago, In October 2010, I published an article describing the results I had obtained following a strategy that I first devised in December 2008.
It involves differentiating between stocks that are growing by selling more products (organic growers) versus those that depend on acquisitions (serial acquirers) to maintain growth.
My original premise was that the organic growers were better bets than those growing by acquisition. My rationale was that as serial acquirers grow, they must continuously find bigger acquisition targets to maintain the same percentage growth rate. Eventually, the numbers get too big and growth slows.
Tracking the returns of my portfolios constructed in December 2008 showed that I was right, but with a twist. Although the organic growers generated returns roughly double the serial acquirers, both groups outperformed the overall market.
Last week, that pattern persisted when I tabulated the returns of the portfolios that I built when I described the strategy in my October 2010 article. From October 22, 2010 through October 24, 2011, my portfolio of nine organic growers averaged a 35% return compared to 19% for the serial acquirers and 6% for S&P 500 index.
Here's a summary of my earlier tests. In one instance, I tracked the returns of a list of 16 organic growers and 16 serial acquirers compiled as of December 31, 2008 and tracked through September 30, 2010. During that period, the S&P 500 gained 26%. My organic growers returned 79% compared to 44% for the serial acquirers. Another time, I tabulated the returns of a list compiled in March 2009 through October 2010. There, the organic growers returned 116% vs. 56% for the serial acquirers and 44% for the S&P 500.
For sure, my three tests don't constitute rigerous proof. Further, I don't know why the serial acquirers, although underperforming the organic growers, still beat the overall market. Nevertheless, my results were consistent enough to encourage me to generate new Organic and Serial Acquirer portfolios, that i'll share with you at the end. First, I'll show you how you determine whether your stocks are organic growers, serial acquirers, or neither, and then give you current lists of stocks in both categories.
Acquisitions Leave a Trail
When a firm acquires another company, it typically pays more than the target firm’s accounting book value. When that happens, the acquirer adds the difference to either the goodwill or intangibles lines on its balance sheet. In fact, acquisitions are the only way that numbers get added to those categories. Both would be zero if a company has never made any acquisitions.
You can find out if a firm is an active acquirer by looking at the goodwill and/or intangibles numbers on its balance sheet. But, many firms that aren’t using acquisitions to fuel growth have made a few strategic buys over the years. So you have to compare the numbers to something that reflects company size. I’ve found that ‘total assets’ does the job. It’s listed close to goodwill and intangibles on the balance sheet, so you can do your analysis quickly.
Simply compare the total of goodwill plus intangibles to total assets. I call the result the “acquisitions ratio.” The higher the ratio, the more acquisitive the firm.
Apple vs. Kraft Foods
You can find the needed information on many financial sites. I’ll describe the process using Yahoo Finance (finance.yahoo.com), starting with Apple (ticker symbol AAPL).
First get a quote and then select Balance Sheet in the Financials section. Finally, select Quarterly Data so that you’re using the most recent information. Yahoo lists goodwill and intangibles (intangible assets) below long-term investments section, and total assets at the bottom of that section. Always use the most recent information, which was the September 24, 2011 report for Apple. Yahoo listed $896 million for goodwill, 3,536 million for intangibles, and $116,371 million for total assets. Thus, the acquisition ratio for Apple is 4% ($4,432 divided by $116,371).
Next, do the same thing for packaged food products maker Kraft Foods (KFT). Looking at the September 30, 2011 figures, Yahoo listed $37,592 million for goodwill, $25,416 million for intangibles, and $95,832 million for total assets. Doing the math, Kraft’s acquisition ratio was 66%.
The numbers tell us that Apple is growing mainly by developing new products while Kraft is relying mostly on acquisitions to fuel growth.
I consider that ratios of five percent or lower signal organic growers and ratios above 15 percent define serial acquirers. However, those numbers are arbitrary and I wouldn’t argue if you used different rules.
Here's are my two new portfolios. Since I don't have room to list every stock meeting my Organic Grower and Serial Acquirer criteria, I limited the list to well-known large-cap stocks.
I can’t list every stock, so here are the acquisition ratios for a sampling of familiar firms.
• Amazon.com (NASDAQ:AMZN) 0%
• Bed Bath & Beyond (NASDAQ:BBBY) 0%
• Chipotle Mexican Grill (NYSE:CMG) 0%
• Coach (NYSE:COH) 0%
• Conoco Philips (NYSE:COP) 3%
• Deere & Company (NYSE:DE) 2%
• Discover Financial Services (NYSE:DFS) 1%
• Fossil (NASDAQ:FOSL) 4%
• Hewlett-Packard Company (NYSE:HPQ) 0%
• Kohl's (NYSE:KSS) 0%
• NIKE (NYSE:NKE) 5%
• Nordstrom (NYSE:JWN) 0%
• Safeway (NYSE:SWY) 0%
• SanDisk (SNDK) 5%
• Target (NYSE:TGT) 0%
• Abbott Laboratories (NYSE:ABT) 45%
• Adobe Systems (NASDAQ:ADBE) 50%
• AT&T (NYSE:T) 48%
• Comcast (NASDAQ:CMCSA) 70%
• Intuit (NASDAQ:INTU) 43%
• Juniper Networks (NYSE:JNPR) 42%
• Kraft Foods (KFT) 66%
• PepsiCo (NYSE:PEP) 45%
• Pfizer (NYSE:PFE) 51%
• Procter & Gamble Company (NYSE:PG) 64%
• Symantec (NASDAQ:SYMC) 61%
• Visa (NYSE:V) 66%
• Walt Disney (NYSE:DIS) 47%
Given my scimpy data, simply qualifying as an organic grower doesn’t mean that you’ll make money owning a stock. Still, it will be interesting to track these porfolios over a year or so. I'll report back in about six months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.