I run a three-pronged value stock screener to find companies that the market has undervalued. You may need this value stock screener more and more in the coming years. Let me explain.
Interest Rates are beginning to rise and will very likely continue to increase at a steady pace during the next couple of years. The Federal Open Market Committee (FOMC) is expected to raise the federal funds rate by a quarter point (one quarter of one percent) two more times in 2017, followed by three increases in 2018. If these raises occur, the federal funds rate will rise to a range of 2.00%–2.25% by the end of 2018. The increase is not alarming, but you might want to adjust your stock and bond portfolio accordingly, as explained next.
What is the FOMC and what do they do? The FOMC is a committee within the Federal Reserve System that sets monetary policy. It specifies the short-term objective for the Fed’s open market operations, which is usually a target level for the federal funds rate. This is the rate that commercial banks charge among themselves for overnight loans.
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When interest rates advance, companies in the financial sector, such as banks and insurance companies, tend to perform well. These companies are heavily invested in bonds, and their bond income will increase as interest rates increase. Conversely, companies carrying heavy debt loads, such as utility companies, often perform poorly while interest rates are climbing.
I use a value stock screener to locate solid companies with low debt. Most databases are extensive, containing a myriad of financial data and information on thousands of companies. I find the best way to wade through the data is to set up a screen to find companies with the criteria and attributes that I want.
How My Value Stock Screener Works
My Screen to find companies with low debt on their balance sheets includes several parameters. First, I set up a simple equation to measure the amount of debt. Benjamin Graham, considered the father of value investing, measured debt by dividing each company’s long-term debt by its current assets. I use that formula in tandem with another formula to measure each company’s current assets. This formula is simply each company’s: current assets divided by its current liabilities.
I like dividends – when reinvested in additional shares the compounding effect makes a world of difference in the performance of my portfolio. The recent interest rate hike by the FOMC has caused the yield on the 10-year Treasury Note to rise to about 2.5%. Therefore, I want stocks with dividend yields of 2.5% or more.
My three screening criteria are summed up below:
- Debt Burden (Long Term Debt divided by Current Assets) = less than 5%
- Current Ratio (Current Assets divided by Current Liabilities) = greater than 2.00
- Dividend Yield = 2.5% or greater
The Results of my three-pronged value stock screener using my 1,000-stock Benjamin Graham database include the following 10 stocks:
American Eagle Outfitters (AEO) – Apparel Retail
AVX Corp. (AVX) – Electronic Components
Consolidated Water (CWCO) – Water Utilities
Daktronics Inc. (DAKT) – Electronic Equipment & Instruments
DSW Inc. (DSW) – Apparel Retail
Garmin (GRMN) – Consumer Electronics
National Instruments (NATI) – Electronic Equipment & Instruments
National Presto Industries (NPK) – Aerospace & Defense
PetMed Express (PETS) – Internet & Direct Marketing Retail
T. Rowe Price Group (TROW) – Asset Management & Custody Banks
These companies are well qualified to weather any storms whipped up by concerns over rising interest rates. Each company boasts a strong balance sheet with ample current assets to maintain future growth. In addition, these companies will likely attract new investors searching for dividend income that is higher than the current interest earned on 10-year Treasury Notes.
Data screens are nice, but they only tell half of the story. The companies’ future prospects need to be examined before purchasing any of the stocks. I rely on research reports and each company’s website to form my opinion on whether each company’s future outlook is worthy of my purchase. Upon further research, I found that one company stands out from the other nine.
One Company Stands Out from the Other Nine
T. Rowe Price Group (TROW), founded in 1937 with headquarters in Baltimore, Maryland, is the investment advisor to the T. Rowe Price family of no-load mutual funds. The company is one of the largest mutual fund companies in the U.S. T. Rowe offers mutual funds and separate accounts that employ a broad range of investment styles, including growth, value, sector, tax-efficient and index-oriented approaches. The company currently manages $811 billion in assets.
T. Rowe Price’s broad line of no-load mutual funds makes it easy for investors to reallocate assets among funds (which is not possible at smaller fund companies), contributing to increased client retention. The company also manages private accounts for individuals and institutions.
T. Rowe Price’s mutual funds outperformed 84% of their benchmark averages during the past three years. However, 2016 net cash outflows totaled $2.8 billion. Clients pulled money from the company’s actively managed stock funds and switched to index and ETF funds offered by competitors, which have lower fees. However, T. Rowe ‘s superior fund performance, more than offset outflows to ETFs and index funds. Revenue advanced 2.4% in 2016 and will likely climb 3.2% in 2017.
Revenue growth was partly offset by rising operating expenses which increased 8.2%. Expenses should begin to decline in the second half of 2017 as new in-house technology initiatives enhance cost efficiencies. In addition, the company will launch new investment strategies and vehicles to stem the flow of funds to competitor’s ETFs and index funds. EPS (earnings per share) will likely rise from $4.75 in 2016 to $4.85 in 2017 and $5.20 in 2018 as expenses moderate.
T. Rowe Price’s revenue and earnings could be further bolstered by less stringent financial regulations proposed by the Trump administration and by a more robust U.S. economy. At 13.8 times 2016 EPS and with a generous dividend yield of 3.3%, TROW is clearly undervalued.
The company, a Dividend Aristocrat, increased its dividend for the 31st consecutive year when it hiked the quarterly dividend to $0.57 from $0.54 with the March payment. T. Rowe’s balance sheet is pristine with no long-term debt and with current assets outweighing current liabilities by four to one. I believe TROW’s stock price will rise 31% to my sell target price of 90.9 within 12 to 18 months. Buy now.
In tomorrow’s Wall Street’s Best Daily, I’ll switch from value investing to growth investing and feature 10 growth stocks with minimal long-term debt. I encourage you to read my column. Your financial education and investing success is my top priority.
Timothy Lutts heads one of America’s most respected independent investment advisory services. Each week, Tim personally picks the single best stock in his exclusive Cabot Stock of the Week advisory. Build your wealth and reduce your risk with the top stock each week for current market conditionsLearn More