In today’s Investment of the Week, J. Royden Ward, editor of Cabot Benjamin Graham Value Letter explains his approach to finding the winning undervalued stocks and recommends two high-quality undervalued stocks.
“My best stock screen approach, which is easy to create, searches for companies with all of the following:
“S&P (Standard & Poor’s) Star Ratings of 4 or higher, S&P Fair Value Rankings of 4 or higher, S&P Earnings/Dividend Ratings of A- or higher, S&P Beta Ratings below 1.40, and Dividend Yields greater than 1.0%.
“In addition, I require companies to be included in one of the following S&P sectors: Consumer Discretionary, Consumer Staples, Health Care, Industrials or Information Technology.
“My brokerage firm has a handy online site which provides the necessary tools to effortlessly find stocks fitting the screens listed above. Your broker likely has similar screening capabilities. Holding a good portion of your portfolio in companies that meet the criteria will greatly reduce your chances of suffering large losses during unforeseen market declines.
“I write the Cabot Benjamin Graham Value Letter and the secret to my success is finding high-quality stocks at bargain prices. I do this by screening ... just as Ben Graham prescribed. My screening methodology lets me whittle my 1,000-stock database down to a few buy candidates.
“If you pay attention to the fundamentals and buy at reasonable prices, profits will add up quickly!
“My system is simple: buy high-quality stocks when they are undervalued, and sell when the stocks become overvalued. Buy low and sell high—it doesn’t get any simpler!
“Two companies that currently fit my screening criteria for undervalued stocks with low volatility and high quality are PetSmart and Target.
“PetSmart (PETM) provides top-quality pet products and services in North America. In 2012, PetSmart’s 1,278 stores produced an industry-leading $6.8 billion in revenue. Most stores are located in the U.S. but 73 are in Canada and five are in Puerto Rico.
“PetSmart stores carry a broad selection of high-quality pet supplies at everyday low prices. The stores offer 10,000 items, including both nationally recognized brand names and private brands.
“The company’s extensive product assortment is complemented by value-added pet services, including grooming, pet training, boarding and day camp. Virtually all of its stores offer complete pet training services and feature pet styling salons that provide high-quality grooming services.
‘PetSmart emphasizes premium dog and cat foods, many of which are not available at supermarkets, warehouse clubs or mass merchandisers. The company also offers its own brands in supermarkets and pet stores.
“In addition, PetSmart offers full-service veterinary hospitals in 799 of its stores. Medical Management International operates 791 of the hospitals under the name of Banfield, The Pet Hospital.
“PetsHotels provide boarding for dogs and cats, 24-hour supervision, an on-call veterinarian, temperature-controlled rooms and suites, daily specialty treats and play time, as well as day camp for dogs. As of January 31, 2013, PetSmart operated 196 PetsHotels within retail stores, and expects to expand this concept. The Doggie Day Camp concept is available at all PetsHotel locations.
“Sales advanced 10% during the past 12 months while EPS (earnings per share) soared 39%. I expect sales and earnings growth to slow during the next 12-month period ending 1/31/14. Management also expects slower growth: the announcement of this caused PETM’s stock price to drop to a more reasonable price. I forecast steady 16% earnings growth during the next several years.
“PETM shares are reasonably valued at 17.9 times current EPS with a dividend yield of 1.1%. The company’s ratings include: S&P Stars Rank of 4, S&P Fair Value Rank of 4, S&P Quality Rank of A, and an S&P Beta Rating of 0.68. The company operates in a recession-resistant industry. BUY.
“Target Corp. (TGT), formerly Dayton Hudson, was founded in 1902 and maintains executive offices in Minneapolis, Minnesota. The company is the second-largest discount retailer in the U.S., behind Wal-Mart Stores. Target stores carry a broad assortment of fashion apparel, electronics, home furnishings and household products at competitive prices. SuperTarget stores are larger and carry a full line of groceries. CityTargets are slightly smaller and tailored toward urban markets.
“Target. com offers a more extensive selection of merchandise than the company’s physical stores, including exclusive online products. To support sales and earnings growth, Target offers credit to qualified customers through its REDcard. Target will sell its credit card receivables to TD Bank in about six months for $5.6 billion.
“Two years ago, Target purchased 220 Zellers stores in Canada, and has sold or sub-leased over 80 of the stores after the purchase. Target has converted or rebuilt 125 stores, which will be ready to open during the next 12 months. The new stores in Canada are expected to add sizeable sales and earnings in 2013.
“Growth has slowed during the past year because of the Zellers project in Canada and extensive remodeling in the U.S. During the next two years, though, sales and earnings growth acceleration will be impressive. EPS will likely increase 9% during the 12 months ending 1/31/14 and another 15% in the following year.
“At 14.9 times latest EPS and with a dividend yield of 2.2%, TGT shares are quite attractive. The company’s ratings include: S&P Stars Rank of 5, S&P Fair Value Rank of 5, S&P Quality Rank of A+, and an S&P Beta Rating of 0.93. Target has paid dividends since 1965 and increased its dividend every year during the past 41 years. BUY.—-J. Royden Ward, Cabot Benjamin Graham Value Letter, March 2013
If you want to continue to follow PetSmart and Target, as well as many other undervalued, high-quality companies in my Cabot Benjamin Graham Value Letter. If you would like to join the list of the subscribers, please click here.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of Investment of the Week
