Everyone says that they want to own great businesses at reasonable or better prices, but in practice this can be difficult to execute. One way to begin to think about the process is by using a couple of simple screens.
When we think about a “great” or “quality” business that can mean different things to different people – pricing power, balance sheet strength, brand name, dividend record, earnings consistency, etc. However, we can use a proxy to get started. For instance, Value Line provides a “financial strength” rating for each security ranging from “C” (worst) to “A++” (best). If we only look at the highest rated securities, “A++,” we go from a universe of ~4,700 possibilities down to just 74 names.
Of course, this is not a perfect process. It leaves out very good companies like Colgate-Palmolive (CL), Lowe’s (LOW) and Walgreens (WBA). Still, it gets the gist correct with the Apples (AAPL), Berkshire Hathaways (BRK.A) (BRK.B) and Johnson & Johnsons (JNJ) of the world.
Once you’ve whittled down your list to just those dozens of high-quality firms, one more screen will give you a starting place for further research: looking for securities with low share prices as of late. And instead of looking at the current share price against a company’s 52-week low, we’ll take it a step further and compare the current quotation against the lowest share price in the last five years. (Incidentally, this data is available in Seeking Alpha’s Portfolio section.)
After just these two screens, five names stand out:
- Anheuser-Busch InBev (BUD) = ~1% above 5-year low
- Franklin Resources (BEN) = ~1% above 5-year low
- Schlumberger (SLB) = ~2% above 5-year low
- AT&T (T) = ~7% above 5-year low
- McKesson (MCK) = ~14% above 5-year low
Granted one could argue that valuation matters more than share price, but I would still contend that you have a reasonable proxy here. Frankly, I was a bit surprised you could find five high-quality businesses trading so close to 5-year lows, given the general stock price environment we have seen for the last decade.
Each security has similarities (they all fit the screen after all) but there are also slightly different stories to tell.
When you look at something like Anheuser-Busch, I would argue that it made the above list largely as a result of high valuation getting back to a slightly more normal one. In the 2012 through 2015 stretch, Anheuser was earning between ~$4.50 and ~$5.50 per share. Meanwhile, the valuation drifted from ~15 times earnings back in 2011 up to the 20 to 25 range during those years.
Now the business is still expected to earn between ~$4.50 and ~$5.50 in the next couple of years and the share price has drifted from ~$130 down to ~$84 – a material decline, but still not exactly screaming out from a valuation standpoint.
Franklin Resources is an interesting story. For a few decades, the company could boast about being a better investment than Apple or Berkshire Hathaway. Recently that hasn’t been anywhere close to the case, as the share price has been halved from a high near $60 in 2014 down to ~$29 today.
Part of the problem has been the lack of growth: earnings per share topped out around $3.80 in 2014 and are now expected to be around $3.15 this year. Moreover, industry concerns loom large as the “race to the bottom,” in regards to fees, heats up. Still, the security is trading around 9 times earnings with a 3.2% dividend yield that is backed up by one of the better balance sheets that you’ll ever see. Last quarter Franklin Resources reported $15.5 billion in total assets, with $6.4 billion of that in cash, against $3.3 billion in total liabilities.
Schlumberger is reminiscent of Anheuser-Busch, albeit with a bit more cyclicality mixed in. You can rarely point to shares and say, “that’s a bargain” in the traditional sense. In the “good” times the company was earning $4+ per share, but often trading with a valuation north of 20 times earnings. In the lesser times of late, the company has been earning ~$1 to ~$2 per share and shares still trade near $60. For the security to look interesting you have to believe in a full recovery and growth story to come.
AT&T has some interesting characteristics. There are things to dislike about the business including a huge debt load, unanswered merger questions and slow overall growth. Some may not be surprised to see the security near its 5-year low.
Yet there are plenty of positives to point out as well. For instance, even though AT&T is near its 5-year low, longer-term investors would still be looking at decent returns due to the well above-average dividend yield. If the share price were to remain stagnant for the next five years, that would still imply ~6%+ annual returns from the dividend alone. Plus, earnings per share have been ticking upward (up ~40% in the last five years), the dividend is steady, the payout ratio has actually been declining and today shares trade around 9 times anticipated earnings. From this point, you have a relatively low “investment bar” where you don’t need much improvement to see solid returns.
Finally, McKesson faces the cloud of drug pricing uncertainty/pressure and the potential for Amazon (AMZN) disruption. Yet, like some of the other securities, the valuation has certainly reflected this. Moreover, the business is still expected to grow, albeit at a reduced rate.
From fiscal year 2013 to 2015, the company’s earnings per share jumped ~75% and yet the share price went up ~110%. In turn, this meant that the valuation went from ~17 times earnings up to 20 times. In the next three years earnings would climb further, increasing another ~14%. Yet this time the share price dropped from ~$226 all the way down to today’s mark closer to ~$131, as the valuation has been cut in half from 20 down to ~10 times earnings.
In short, the five companies mentioned above share two things: a quality base and a much lower share price. This does not automatically make them good investments. However, if you’re looking for high-quality businesses with materially lower share prices, the above names offer an ideal starting place to begin learning more. The idea is not to screen for the perfect investment, instead it’s about identifying the types of investments you would like to own and flipping over rocks to try to find those opportunities.
Disclosure: I am/we are long BRK.B, JNJ, T, BEN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.