Jubak's Journal
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5 stealth blue-chip stocks
It's time to break out from the list of stocks people far too often turn to when they invest. Here are some lesser-known stocks that have blue-chip qualities.
By Jim Jubak
Look at the list of the 20 stocks most widely held by individual investors. According to Merrill Lynch, it includes Time Warner (TWX, news, msgs), four spin offs from the old AT&T (T, news, msgs), AT&T Wireless (AWE, news, msgs), Agere Systems (AGR.B, news, msgs), Avaya (AV, news, msgs) and Lucent Technologies (LU, news, msgs), two of the old Baby Bells, SBC Communications (SBC, news, msgs) and Verizon Communications (VZ, news, msgs), and some big household names like General Electric (GE, news, msgs) and Merck (MRK, news, msgs) that have struggled to grow revenues lately.
All in all, the list is a tribute to many investors tendency to equate familiarity with safety and with solid investment returns. When we go looking for blue chips, we tend to look for big companies with names we recognize, figuring that theyre too big to fail and that such fixtures on the economic landscape must be solid investments.
But investors can beat the performance of those names if they take off those blinders and go looking for what they want from a blue chip among stocks that they've never heard of. Some little known stocks, what I called stealth blue chips in the first column I wrote on this idea on Oct 14, 2003, combine exactly the steady year-in-year-out growth, the safety in an economic and market downturn and the above-average performance that we want from a true blue chip.
How has that initial list of eight stealth blue chips done since I first recommended them? Just as youd hope for from a blue chip portfolio, it has delivered well above-average returns in a period when the market has gone just about nowhere despite its ups and downs. The initial list of stealth blue chips was up 12.6% from Oct. 14, 2003 through June 20. In comparison, the Standard & Poor's 500 Index gained just 5% and the Nasdaq fell 2%.
| Stealth blue chip candidates | | Stock | Recommended price 10/14/2003 | Closing price 7/20/2004 | Gain/Loss | StockScouter rating | | Affiliated Computer Service (ACS, news, msgs) | $49.90 | $53.42 | 7.1% | 7 | | Applebee's (APPB, news, msgs) | $22.73 | $26.13 | 15.0% | 9 | | Chico's (CHS, news, msgs) | $36.90 | $42.20 | 14.4% | 10 | | Donaldson (DCI, news, msgs) | $28.60 | $26.84 | -6.2% | 8 | | Expeditors International (EXPD, news, msgs) | $37.18 | $49.88 | 34.2% | 9 | | Kinder Morgan Energy Partners (KMP, news, msgs) | $44.17 | $44.74 | 1.3% | 6 | | Main Street Banks (MSDK, news, msgs) | $25.98 | $28.47 | 9.6% | 5 | | SCP Pool (POOL, news, msgs) | $30.60 | $44.48 | 45.4% | 10 | | | | | | | Portfolio gain/loss | | | 13.3% | | | S&P 500 gain/loss | | | 6.0% | | | Nasdaq composite gain loss | | | -1.0% | |
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Running a screen
So with that success in mind, Ive run the same screen again and come up with five more stealth blue chips.
To make the cut a stock had to have a market capitalization above $193 million, which ruled out the least liquid quarter of all stocks. Annualized earnings per share growth had to be above 10% on average for the last three years, and the company had to show positive earnings per share growth in each of the last four years. Annual returns from the stock had to be in the top half of all stocks for each year stretching back to 1998, and in the very tough year of 2002, the stock couldnt show a loss of more than 13%.This would put the shares in the top quarter of all stock performance that year. The stock also had to show a better than 1% return this year, which would put the stock in the top half of all stocks for 2004.
Finally, the stocks had to show a five-year return that beat the S&P 500.
Only 33 stocks passed these test. And Ive picked the best of that already short list.
In my due diligence, I looked for the stocks of companies with the potential to sustain their past performance for the next five years. If the record of the last five years was built on conditions that seemed unlikely to be repeated over the next five years, such as rapidly falling interest rates, I took the stock out of the running.
Playing self-interest
Expeditors International of Washington (EXPD, news, msgs). It's a company with a high-octane business model driven by a culture that ties every employees self-interest to the company and its shareholders. Expeditors International doesnt own any planes or trucks. Instead, it buys bulk space on other carriers and resells it to customers. This low-asset business model is one reason that Expeditors International shows an average annual return on invested capital of 21% for the last five years.
The other part of Expeditors Internationals blue-chip performance is a result of the incentives employees have to cut costs. Everyone from top to bottom at the company works for a relatively low base salary and a bonus based on the companys pre-bonus operating income. Individual Expeditors International offices retain 20% of their operating profits for distribution to employees: Needless to say that with base salaries low, increasing that local bonus pool is a big incentive for working hard and cutting costs. The company has grown earnings per share by an average of 19% a year over the last five years.
Betting on a payoff
Penn National Gaming (PENN, news, msgs). It has generated average annual earnings per share growth of 44.6% over the last five years out of its seven casinos in Illinois, Mississippi, Colorado and Louisiana, and its four racetracks and 11 off-track bettering business in West Virginia, New Jersey and Pennsylvania. Recent legislation that legalized slot machines in Pennsylvania gives the company a solid path to short-term growth. The addition of slots to its Pennsylvania operations will add about 40 cents a share to earnings in 2006, Wall Street estimates.
In the long term, states hungry for revenue but reluctant to raise taxes will increasingly turn to legalized gambling, opening new opportunities for Penn National. At 4.6%, the companys average annual return on invested capital over the last five years doesnt look particularly impressive until you note that it's almost three times the return on invested capital for the gaming industry.
Filtering profits
Cuno (CUNO, news, msgs). Theres clearly money to be made by filtering stuff out. Cuno has grown annual earnings per share by an average 24.4% a year over the last five years by making filters that purify liquids and gases for the health care and manufacturing industries and for consumers who want clean drinking water.
The potable water part of Cunos business, about 45% of sales, will get a big boost from the companys acquisition of WTC Industries. That deal will make Cuno the dominant supplier in the appliance filtration segment with sales to refrigerator makers GE, Whirlpool (WHR, news, msgs) and Maytag (MYG, news, msgs). The acquisition will also advance Cunos penetration of big-box retailers like Home Depot (HD, news, msgs) where WTC Industries already sells filter products for the do-it-yourself market under the General Electric brand.
Cunos average annual return on invested capital has been 13.6% over the last five years, about double the industry average.
Model of consistency
Brown & Brown (BRO, news, msgs). In any industry Brown & Brown would be a model of consistency, but in the notoriously volatile insurance business, its a standout. Return on equity hasn't fallen below 20% in the last 10 years nor has it climbed much above 30%. In the most recent quarter, Brown & Brown tacked on 5.1% organic growth plus continued the steady stream of acquisitions that has added annual revenue of $86 million to the companys books this year.
Throw in a one percentage point improvement in margin and the company is well on its way to making its target of 15% or better annual earnings per share growth. Recently the emphasis has been on the or better part. Earnings per share have grown an average of 30.6% annually over the last five years. Return on invested capital has averaged 20.9% over the same period, about double the industry number.
A growth machine
Chicos FAS (CHS, news, msgs). It made the first stealth blue chip list (as did Expeditors International), and its still delivering the goods to make the list nine months later. Its a measure of how remarkable this growth machine is -- 51% average annual earnings per share growth over the last five years -- that the first quarter was a disappointment when the company delivered just 17% growth. What's the companys second-worst performance in the last eight quarters? The 46% earnings growth in the second quarter of fiscal 2003.
The companys new White House and Soma store lines are one source of new sales, but Chicos still has plenty of tricks left to keep sales per square foot in existing stores growing. The recent addition of outerwear and suits has the potential to drive the companys average price point to $71 from the current $60 over the next five years. Chicos has averaged an annual return on invested capital of 27.7% over the last five years. The average for apparel retailers is 12.6%.
Most of these stocks arent cheap, and Id certainly like to buy any of them after a pullback. But remember that these stocks dont tumble a lot even in the worst of markets, so a 10% correction in price for one of these is a big deal.
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 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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