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"Fire Your Stock Analyst" by Harry Domash
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7 stocks to buy and forget
So-called experts say buy-and-hold investing is dead, but I found 7 stocks with returns that beg to differ. Here's how to find stocks worth forgetting about.
By Harry Domash
Experts tell us that buy-and-hold investing doesnt work anymore.
Thats news to shareholders in retailer Bed Bath & Beyond (BBBY, news, msgs), who have enjoyed 26% average annual returns for each of the past 10 years. Sysco (SYY, news, msgs) is a food distributor, about as boring a business as you could imagine. But Syscos investors probably don't find their brokerage statements tedious at all; Syscos shares have gained 16% annually, on average, also for the past 10 years.
Coincidentally, these are two of the seven stocks that my buy and forget search turned up. The other five picks havent done badly, either. Six of the seven soundly beat both the S&P 500 ($INX) and Nasdaq ($COMPX) returns over the past 10 years. The worst performer, H&R Block (HRB, news, msgs), came out about even with those indices.
Low probability of failure
But I didnt pick my buy-and-forget stocks based on historical performance. That wasnt even a consideration. The goal was to identify a handful of stocks that you could buy and put away, stocks that have the best prospects for price appreciation and a low probability of failure. These are stocks for investors who dont have the time and/or the interest to constantly monitor their holdings.
I used MSNs Deluxe Screener to search out stocks possessing the combination of qualities that, in my view, define the best buy-and-forget candidates. Follow along with me as I describe my rationale for each screening step. Then you can run it as is, or modify it to suit your needs.
Bigger is better
For starters, I figured that the companies that stand the best chance of being around for another 10 years are already big companies. Why?
These companies have already been around the block, so to speak. Theyve faced recessions and hotshot competitors, suffered management miscalculations and didnt get new paradigms. But they survived, and are the stronger for their experiences.
I used market capitalization to define big companies. Market cap (share price multiplied by the number of shares out) is how much youd have to shell out to buy all of a companys stock. Because I wanted only large companies, I figured that large caps, typically defined as companies with market caps in excess of $8 billion or $10 billion, were a good place to start. Using the $8 billion figure, I turned up 438 stocks.
Search term: Market Capitalization >= $8 billion
Employee count confirms
A company can register high in terms of market cap simply because the market has bid up its share price. Insisting on the largest companies in terms of numbers of employees, as well as market cap, ensures that you are indeed looking at substantial companies. The U.S. Census Bureau, which categorizes company size based on employee count, sets the minimum at 10,000 employees to qualify for its largest category. Only 943 companies, or 0.02% of the total in its database, met that requirement, according to the bureaus data for 2000, the latest available. Adding that criterion reduced my list of candidates down to 360 stocks.
Search term: Number of Employees >= 10,000
S&P helps out
Rather than analyze each of those 360 stocks to ferret out the leading companies, I let the experts at Standard & Poor's do the heavy lifting. The S&P 500 Index ($INX) comprises the best companies in the leading industries of the U.S. economy, at least in the eyes of S&Ps analysts. So I added the requirement that buy-and-forget candidates must be members of the index, which cut my universe down to 205 stocks.
Search term: S&P Index Membership = S&P 500
Add the fundamentals
Next, I applied fundamental parameters to pinpoint the best prospects.
Look for profitability. It is arguably more significant than reported earnings because it measures how efficiently a company uses its assets to generate earnings. Return on equity, the most frequently used profitability gauge, compares net income to shareholders equity (book value).
If you do the math, youll find that a company cant grow earnings faster than its ROE without raising additional cash. For instance, if its ROE is 15%, it cant grow earnings faster than 15% annually without borrowing or selling more shares, and both options reduce profits.
So ROE is, in effect, a speed limit on earnings growth, and many money managers wont consider stocks with ROEs below 15%.
Because I was looking for the cream of the crop, I set the minimum ROE (5-year average) at 20%, which narrowed the field down to only 58 candidates.
Search term: 5-year Avg. ROE >= 20%
Probe for profit margins. Certain industries, such as software, dont require huge investments in factories and machinery and typically record higher ROEs than industries that do, such as automakers. I added a requirement that each candidates pretax profit margin equal or exceed its industry average to weed out the profitability laggards. I used the 5-year average margin figures to gain a long-term perspective. Seven companies flunked that test, reducing the candidate total to 51 stocks.
Search term: 5-Year Avg. Pre-Tax Profit Margin >= 5-Year Avg. Industry Pre-Tax Margin
Bar the big borrowers. Heavy borrowers can run into problems servicing their debt when business slows. Further, a rising interest rate environment increases loan-servicing costs, thereby pressuring profits. Bottom line: Companies carrying high-debt are more problematic than those that dont.
The definition of high debt, however, varies with each industry. Typically, companies in industries with predictable revenue streams, such as utilities or insurance companies, carry higher debt than, say, tech companies.
The debt-to-equity ratio compares long-term debt with shareholder equity. The more debt, the higher the ratio. I eliminated candidates with D/E ratios higher than their industry average to avoid the heaviest borrowers. That requirement lopped another 21 companies off the list, leaving only 30 survivors.
Search term: Debt/Equity Ratio <= Industry Avg. D/E
Follow the big buyers. Mutual funds, pension plans and other institutional buyers employ squads of analysts and are otherwise wired into the system. So it makes sense to piggyback on their research and avoid stocks that the big boys are shunning. I required at least 50% institutional ownership, meaning that institutional buyers must hold at least 50% of the outstanding shares. Five stocks flunked that test, leaving me with 25 candidates.
Search term: Institutional Ownership >= 50%
Go for growth. Companies must grow to justify long-term stock price appreciation. Sure, they can temporarily boost earnings by cutting costs. But in the end, growth comes from selling more products and/or services. I added a minimum 5% average annual historical sales growth requirement to weed out slow- or no-growth companies. Adding that constraint cut the list down to only 14 stocks.
Search term: 5-year Revenue Growth >= 5%
Weed out the slower growers. Historical growth figures can be misleading. For instance, a company in a slow- or no-growth industry may have recently acquired a competitor. In that case, historical growth isnt indicative of future prospects.
Despite their sullied reputation, stock analysts do a reasonable job of quantifying earnings-growth prospects. So you can use their long-term earnings-growth forecasts to weed out stocks with poor future prospects.
I set the minimum forecasted annual earnings-growth rate at 12%, more or less the minimum qualification for a growth stock. That test leaves me with just eight companies.
Search term: EPS Growth Next 5-Years => 12%
Growth for next fiscal year. This is a check on lazy analysts -- sometimes analysts are slow to reduce their long-term forecasts, even though theyve soured on a companys earnings-growth prospects. Checking the next fiscal years expected earnings growth helps to eliminate stocks in that category. I cut the candidates a little slack, requiring only 10% EPS growth for the next fiscal year, year-over-year. Doing that knocked one more stock out of the box, leaving me with my final seven candidates.
Search term: Next Year Growth Rate >= 10%
And the winners are
These are the seven buy-and-forget candidates that turned up when I ran the screen.- Pfizer (PFE, news, msgs): It is the worlds largest pharmaceuticals developer and manufacturer; it has a $240 billion market cap and annual sales exceeding $38 billion.
- TJX Cos. (TJX, news, msgs): With more than 1,300 stores operating under names such as T.J. Maxx and Marshalls, TJX is the largest off-price clothing retailer in the U.S.
- Sysco (SYY, news, msgs): Distributes food and related products to more than 400,000 restaurants, health-care and educational facilities, hotels and the like.
- MBNA (KRB, news, msgs): Operator of MBNA America Bank. It's the world's second-largest issuer of bank credit cards.
- Apollo Group (APOL, news, msgs): Provides higher education for working adults under names such as University of Phoenix, University of Phoenix Online, Institute for Professional Development and Western International University.
- Bed Bath & Beyond (BBBY, news, msgs): Operates more than 500 retail stores selling domestics merchandise such as linens, bath accessories, cookware and home decor items.
- H&R Block (HRB, news, msgs): It's the worlds largest tax-preparation company and also offers mortgage and investment products.
Remember, the result of any screen, no matter how soundly designed, is a list of research candidates, not a buy list. Even after you do your due diligence, some of your final picks are bound to disappoint, so diversification is a must.
If you want to dollar-cost-average into these stocks, or your budget doesnt allow for buying all of your final candidates through a regular broker, consider a broker that is set up to handle fractional share purchases and regular monthly investments. ShareBuilder is one such broker.
At the time of publication, Harry Domash did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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