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2 Strategies to Find Leading Value Stocks

The two strategies that I use to find consistent winning stocks involve evaluating sales and book value. I prefer sales and book value rather than earnings, because earnings fluctuate wildly and are often engineered, using an endless system of “adjustments.” Valuations based on sales or book values are more reliable when assessing the past, present and future prospects for companies.

Value is Indeed Back

Last month, I wrote that value stocks were poised to outperform growth stocks during the next several years. Here was my thinking: Since 2000, growth stocks have outperformed value stocks by a very wide margin, resulting in growth stock valuations that are now stretched to the limit; meanwhile, value stocks have been totally neglected and are due for a comeback.

Despite the stock market’s climb to lofty levels, many undervalued stocks are selling at bargain prices. Value stocks are now too inexpensive to ignore!

In that March Cabot Wealth Advisory, I listed 10 stocks that had declined significantly during the past 12 months, but are likely to recover during the next 12 months. To review my analysis and list of 10 buy recommendations, click here.

Those recommendations are off to a good start. Nine of the 10 stocks are up, and the average gain since March 16 is 7.8%, compared to a lesser gain of 3.2% for the Standard & Poor’s 500 Index.

The two strategies that I use to find these types of consistent winners involve evaluating sales and book value. I prefer sales and book value rather than earnings, because earnings fluctuate wildly and are often engineered, using an endless system of “adjustments.” Valuations based on sales or book values are more reliable when assessing the past, present and future prospects for companies.

The First Strategy: Finding Consistent Sales Growth

One excellent methodology that I use to uncover winning value stocks involves evaluating sales.

If a company’s sales are increasing every year, even when the economy is weak, I’m interested in the potential of its stock. Many companies are cutting costs, and that is good, but if their sales aren’t growing, their future growth is jeopardized. What the companies are doing is downsizing the company, which will lead to stock price erosion sooner rather than later.

One way to avoid a lot of the pitfalls of investing in the wrong stocks is to find companies that have consistently increased sales during the past 10 years and are forecast to continue to grow sales at a fairly rapid pace in the future. Aetna (AET), Dick’s Sporting Goods (DKS) and Walgreen Boots (WBA) are examples of these stocks.

You can find these and many more undervalued companies with low price-to-sales ratios in Cabot Benjamin Graham Value Investor.

The Second Strategy: Finding Consistent Book-Value Growth

Another strategy that I use involves evaluating book value. I find that many investors are unfamiliar with book value and book value per share, so, a quick definition is in order. Book value is a shareholder’s equity (also called retained earnings). Book value per share is simply the shareholder’s equity or retained earnings divided by the number of common shares outstanding.

Is book value per share important? By itself, no. But when compared to the company’s stock price, it’s enormously important. In short, quality companies with low price-to-book value per share ratios (P/BV) have outperformed companies with high ratios for the past several decades.

Eugene Fama, a Nobel laureate from Boston, conducted research to find the best evaluation methods leading to superior performance results over long periods of time. Dr. Fama concluded that from 1928 to 2000, companies with low P/BV ratios outperformed companies with high ratios by a wide margin.

Value stocks have underperformed growth stocks since 2000, one of the longest periods of underperformance in the history of the stock market—and the difference between growth stock and value stock gains is the largest ever recorded. But the wide outperformance enjoyed by growth stocks will end, and now might be that turning point.

Cabot Benjamin Graham Value investor features high-quality companies that have steadily increased book values at least 10% per year during the past decade and are forecast to continue increasing book values at a 10% pace during the next five years or more. In addition, all of the stocks pay a dividend and all of their stock prices are undervalued.

Each stock sells at a price-to-book value ratio of less than 2.00. All companies are expected to report higher book values for the next 12 months. Some examples are: Jabil Circuit (JBL), Toronto Dominion (TD.TO) and World Fuel Services (INT).

Sincerely,

J. Royden Ward
Chief Analyst, Cabot Benjamin Graham Value Investor

J. Royden Ward has spent his entire career seeking strong investment returns for his clients while keeping risk low. In 1969, he developed a computerized model of stock selection based on formulas created by investment legend—and Warren Buffett mentor—Benjamin Graham, and since 2003, he’s been spreading his wisdom far and wide as chief analyst of Cabot Benjamin Graham Value Investor.