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| The Basics | Put your stocks on autopilot this summer
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Here's how to set up a strong portfolio of stocks that can ride out the summer without a lot of babysitting and greet you with a nice return come fall.
By Harry Domash
Its May, but dont go away.
Yes, more often than not, the market typically goes nowhere during the summer (thus the old Wall Street saying: Sell in May and go away). But every year is different, and nobody really knows what will happen this summer.
Heres a screen for finding summer stocks. These are safe stocks selected to do well in a go-nowhere market, and theyll do even better if the market surprises on the upside.
My Summer Stock screen is designed to pinpoint low-risk stocks with appreciation potential. It focuses on high-dividend stocks, because the high yields will help to shield the stocks against market downdrafts. From this high-dividend universe, the screen picks the safest bets based on company size, profitability, analyst ratings and MSNs exclusive StockScouter risk rating. Finally, from those survivors, it isolates the stocks with the best price-appreciation prospects, based on relative strength and the StockScouters return rating.
Here are the details.
Dividends pay
Dividend yield is the expected next-12-months dividends divided by the recent share price. For instance, the yield for a stock trading at $10 and expected to pay a 50 cent-a-share dividend is 5% ($0.50 divided by $10).
Assuming that a companys dividend is considered a sure thing, a significant dividend yield will soften share-price downdrafts when the market takes a dive. For instance, suppose that the $10 stock I just mentioned drops to $7.50 per share. In that case, the dividend yield would jump to 6.7% ($0.50 divided by $7.50), which would attract more buyers.
Another advantage of sticking with stocks paying significant dividends is that youll make money even if the share price goes nowhere. Whats a significant yield? I arbitrarily set my minimum at 4.5%, because yields above that figure seem to attract investors attention. You could increase that figure up to 5% or so, but dont reduce it.
Screening parameter: Current Dividend Yield >= 4.5
Small company = big risk
In my experience, when the market turns sour, small companies usually take the biggest beatings. So, to minimize risk, its important to rule out the small companies that are likely to keep you awake nights.
Market capitalization, which is calculated by multiplying the recent share price by the number of shares outstanding, is the standard tool for measuring company size. Definitions vary, but market caps below $1 billion usually define small-cap stocks. Stocks with market caps above $8 billion or $10 billion are large-caps, and those in between are mid-caps.
I require a minimum $1 billion market cap to disqualify small-cap stocks.
Screening parameter: Market Capitalization >= $1 billion (entered as 1,000,000,000)
Generally, the bigger the firm, the lower the risk, so consider increasing the minimum market-cap to $2 billion if your screen turns up too many hits.
Profitability counts
Some firms appear profitable because they are reporting positive earnings but, it fact, they require continuous cash infusions to maintain earnings growth. So, finding the best Summer Stock candidates requires identifying truly profitable companies.
Profitability measures how efficiently a company uses its assets to generate earnings. One such measure, return on invested capital (ROC), is the ratio of net income to the sum of shareholders equity (book value) plus long-term debt. ROC values can range from negative numbers for unprofitable companies to as high as 25%, and sometimes even higher.
There is no particular value of ROC that defines a profitable firm. However, safe stocks are not the fastest growers, so I figured that firms with 10% ROCs, which could grow annual earnings in the 10% to 15% range depending on their debt levels, would be sufficient.
Screening parameter: Return on Invested Capital: 5-year Avg. >= 10%
Let the analysts do the work
Rather than analyze dozens of stocks in detail, I prefer to let the analysts do the work. Sure, some make bad calls, but analyzing stocks is their day job and most have a decent handle on a companys prospects. If anything, analysts are too optimistic, so a sell rating, in particular, gets my attention.
Agencies such as Zacks Research compile the individual analysts ratings for each stock into consensus ratings according to these categories: strong buy, buy, hold, sell and strong sell.
My screen eliminates all stocks with consensus sell or strong sell ratings.
Screening parameter: Mean Recommendation >= Hold
Yes, it is rocket science
The rocket scientists that produced MSNs StockScouter devised a risk factor that predicts the future volatility that a particular stock is likely to encounter. Possible screening values are very low, low, average, high and very high. I specified average or lower to rule out the riskiest candidates.
Screening parameter: Risk Expectation <= Average
More than safe
So far, Ive concentrated on isolating safe stocks. Now its time to find the stocks in that group that are most likely to make us money.
Once again, the StockScouter rocket scientists to the rescue. They also devised a return factor that identifies the stocks most likely to produce a positive return in the coming months. As with the StockScouter risk factor, the choices are very low, low, average, high and very high. Naturally, I chose high or better.
Screening parameter: Return Expectation >= High
Strong stocks rule
Although this may seem counterintuitive, much research shows that stocks that have already outperformed the market are likely to continue their winning ways. Conversely, those that have underperformed will probably continue to cause anguish for their shareholders.
Relative strength measures a stocks price performance over a specified time frame compared with the overall market. For example, a 12-month relative strength of 90 means a stock has outperformed 90% of all stocks over the past 12 months.
MSNs screener offers three relative strength timeframes: 3 months, 6 months, and 12 months. Ive found that the 12-month period is the most useful.
I set my relative strength minimum at 50%, which rules out stocks that have underperformed the market.
Screening parameter: 12-Month Relative Strength >= 50
My Summer Stock screen turned up 12 stocks in an interesting variety of industries. In fact, the only duplication was two stocks in the steel industry. Surprisingly, even though real-estate-investment trusts make up the majority of high-dividend stocks in the overall market, only one REIT, Rayonier (RYN, news, msgs), passed all of my screening requirements.
| Summer stock screen results | | Company name | Industry name | Last price | Est. annual dividend | Current dividend yield | | AllianceBernstein Holding (AB, news, msgs) | Asset Management | 65.13 | 3.12 | 4.7 | | Allied Capital (ALD, news, msgs) | Closed-End Fund - Debt | 31.32 | 2.40 | 7.7 | | Companhia Siderurgica Nacional (SID, news, msgs) | Steel & Iron | 36.38 | 4.68 | 13.4 | | Energy Transfer Partners (ETP, news, msgs) | Oil & Gas Refining & Marketing | 40.93 | 2.35 | 5.8 | | Koninklijke KPN (KPN, news, msgs) | Telecom Services - Foreign | 11.82 | 0.54 | 4.6 | | Pengrowth Energy Trust (PGH, news, msgs) | Oil & Gas Drilling & Exploration | 24.82 | 2.67 | 10.8 | | Philippine Long Distance Telephone (PHI, news, msgs) | Telecom Services - Foreign | 39.62 | 1.78 | 4.5 | | Rayonier (RYN, news, msgs) | REIT - Diversified | 40.57 | 1.88 | 4.6 | | Reynolds American (RAI, news, msgs) | Cigarettes | 112.34 | 5.00 | 4.5 | | Southern Copper Corporation (PCU, news, msgs) | Copper | 98.58 | 11.00 | 11 | | Tenaris (TS, news, msgs) | Steel & Iron | 46.87 | 3.00 | 6.5 | | World Wrestling Entertainment (WWE, news, msgs) | General Entertainment | 17.45 | 0.96 | 5.6 |
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Four of the stocks listed are foreign stocks trading in on U.S. exchanges as ADRs (American Depositary Receipt). Thats not a bad thing per se, but many foreign stocks pay dividends only once a year, and sometimes irregularly. I prefer to avoid stocks paying annual dividends because you might hold a stock for a year, only to find out that it decided to cut or omit its dividend entirely.
The easiest way to check on a stock's dividend history is to display at least a three-year price chart and then select Dividends under Chart Display Options. Once youve done that, you can move your cursor over each dividend indicator to see the payout details.
Of the stocks listed by my screen, the following pay annual dividends or have an irregular dividend history: Tenaris (TS, news, msgs), and Companhia Siderurgica Nacional (SID, news, msgs).
Pengrowth Energy Trust (PGH, news, msgs) is a Canadian Royalty Trust that pays monthly dividends.
As with all screens, consider the stocks turned up by my Summer Stock screen as research candidates, not a buy list.
At the time of publication, Harry Domash owned shares of Energy Transfer Partner.
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