Related Articles Jubak's Clean Stocks portfolio Jubak's Journal Recent articles: • Buy on bad news -- or steer clear?, 11/12/2004 • 5 ways to play the dollar's decline, 11/10/2004 • Protect yourself from the dollar's decline, 11/9/2004 More... | Jubak's Journal Profit from clean stocks in dirty businesses T. Rowe Price has prospered in part because it has steered clear of the scandals plaguing its industry. That tells me to look for clean names in troubled sectors. By Jim Jubak Studying how you made a profit in the past may be the best way to increase your profits in the future. Thats certainly true for my Clean Stocks portfolio, where one stock that scored unexpectedly large gains could hold the key to a long-term strategy for beating the market over and over again while taking on a very modest amount of risk. Think of this strategy as a way to improve the profitability of any buy-on-the-dip trades you make. (Read my last column, Buy on bad news -- or steer clear? for my take on why its so hard to trade the current round of corporate scandals.) Im certainly pleased that the Clean Stocks portfolio I started on Aug. 1, 2003, continues to beat the Standard & Poors 500 Index ($INX). Since I started the portfolio, the average return for the 10 stocks in the list is 22%, against a 20% return for the S&P 500. The relative performance of the portfolio has been even better in 2004, with the Clean Stocks returning 11.5% and the S&P returning 6%. Scandal-free profits But its the source of that outperformance that I find most interesting -- and potentially most useful for making profitable trades in the future. I would have expected Apache
Its the No. 3 stock on the Clean Stocks hit parade thats unexpected: mutual fund company T. Rowe Price Group Clean Stocks Portfolio Click here to see the stocks that have qualified, their performance and the eight rules used to select them. T. Rowe Price shares may be up strongly in that period for lots of reasons. For example, in its third-quarter report, the company announced that assets under management had climbed to a record $212 billion, up 26% from the third quarter of 2003. It certainly didnt hurt that T. Rowe Price has remained untouched by the scandals that have roiled the industry and sent dollars flowing away from fund groups run by Putnam Investments, a unit of Marsh & McLennan Now, I know that outperformance by one stock no more makes a trend than one swallow makes a spring. But I cant help thinking theres a potential strategy here that deserves testing. Perhaps we can generalize from the T. Rowe Price example and say, The best stock to buy when a scandal taints an industry is the cleanest stock in that industry. Im going to use the next two Clean Stocks columns to test that hypothesis by looking for potential Clean Stocks in the insurance, drug and brokerage industries. The Clean Stocks model I launched this cooperative effort to build a list of clean stocks in July 2003 in my column, "Join forces to build a list of stocks to trust." Over the months, readers helped me develop a final list and refine the set of eight rules that now form the test stocks must pass to be added to the Clean Stock portfolio. To review these rules, click here. In each Clean Stocks column, I put three stocks nominated by readers to the test. Those that make it get added to the portfolio. And I end each column with a request for nominees for the next round. My June 22 column, (Boeing, Motorola, Rite Aid fail the Clean Stocks test), proposed putting the following three reader nominees to the test: Lennar The last of that group is an ideal test stock. Cincinnati Financial is one of those under-the-radar stocks that delivers market-beating returns year after year. For the last 10 years, the stock shows an average annual return of 11.28%, a full 2 percentage points better on average than the annual return on the S&P 500. But Cincinnati Financial, an insurance company, is operating in a troubled industry. Is it clean enough to survive the scandal and join T. Rowe Price in the Clean Stocks portfolio as a scandal survivor? Lennar, wrong on so many levels And what about Lennar? Let me count the ways this company fails the Clean Stock test.
Chicos leadership is lacking Whether Chicos FAS qualifies as a Clean Stock or not comes down to how you evaluate the quality of the companys board of directors. The board is especially important right now because the company, which has been able to grow sales by 48% annually over the last five years, has launched an ambitious range of new ventures to keep sales growing. The biggest is the acquisition of the White House/Black Market brand in 2003. That deal will let Chico expand its customer base to include women in their mid- to late-20s. The company isnt simply buying sales, however, but the opportunity to grow sales: The plan is to double the number of White House/Black Market stores over the next five years. As if thats not enough on the companys plate, Chicos also is introducing a new line of sleepwear, body wear and active wear under the Soma label in its Chicos stores. At the same time, Chicos has to keep its existing, very loyal customer base happy: In fiscal 2003, about 75% of sales came from customers in its frequent-buyer club. Is management up to the challenge? The board seems light on the kind of independent voices with deep industry experience Id like to see at Chicos right now. Four out of eight board members are independent in my judgment, but of those, one is a venture capitalist specializing in technology and life sciences, one was the chairman of Federated Department Stores Cincinnati Financial gets help from its board My first reaction on putting Cincinnati Financial to the Clean Stocks test was, Oh, no, not another board dominated by family members and the company founder. Three Schiffs sit on the board: Robert, 80, the company co-founder; John J. Jr., 60, CEO; and his brother Thomas, 56. But this isnt your standard family-dominated company. First, the board of 15 has, by my count, only four insiders, including the three Schiffs. Its a board with a strong local flavor (the president of the Cincinnati Bengals is a member), but its also heavy on working CEOs. And, by God, these guys are cheap. In 2002, CEO John Schiff Jr. received a salary the compensation committee notes was just 66% of that paid to his peers. And that represented a raise from the 60% of peer salaries he received in 2001. In 2003, he got a jump of 15% to close some of that gap. And options? In October 2003, reviewing the company and the CEOs performance, the compensation committee decided that in recognition of excellent results for 2003, Schiff would receive a bonus of (ready?) $287,500. Thats a lot to you and me, but remember, the CEO of Lennar got a $12 million bonus. Oh, and it came with a suitably stingy grant of 50,000 options. Does this guarantee theres nothing on this insurance companys books like the "finite risk" policies that are now getting Berkshire Hathaway To my mind, Cincinnati Financial looks a lot like T. Rowe Price. Im adding it to the Clean Stocks list. May the shares prosper as much from the turmoil in the insurance industry as T. Rowe Prices did in the mutual fund brouhaha. And speaking of Berkshire Hathaway: The company has been dragged into the investigations of the insurance industry. Has the company done enough wrong to get it kicked off the Clean Stocks list? Ill answer that question and ask for your vote, stay or go, in my next column. And for my next Clean Stocks column, in about a month, Ill look at these three companies in scandal-scarred industries: Pfizer New developments on past columns 5 stocks for the post-election tech rally Now this stock market is getting interesting -- whether or not thats a good thing remains to be determined. All year, the stock market has been tracing out a pattern of lower highs and lower lows. Thats not a good thing, usually. When each rally fails at a lower price and each dip takes stocks lower than the one before, its solid evidence the stock market is in for a long period of decline. Look at the pattern of highs in the Nasdaq Composite Index ($COMPX), for example. The high for the year is still the Jan. 23 high of 2,124. After declining and then rallying from there, the Nasdaq Composite topped out at 2,079 on April 5. The next high was still lower -- 2,035 on June 29 -- and the Oct. 4 high was lower yet at 1,952. Which is why the Nov. 12 close on the Nasdaq at 2,085 is so important. Its higher than the October, June and April highs. And its only 40 points below the Jan. 23 high for 2004. End-of-year rallies live and die on momentum and emotion. The Nov. 12 close just might supply enough of both to take this market back above Januarys high. And that would set dreams of sugar plums dancing in more than one head on Wall Street. The Nasdaq Composite hasnt closed above 2,300 since May 25, 2001. Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Berkshire Hathaway. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||
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