My Low-Debt List Has Shown A Profit 12 Years Out Of 13 by John Dorfman, Dorfman Value Investments
I love to return to stock-picking concepts that have stood the test of time.
One of them is to pick stocks of companies with low debt and high profitability.
When it comes to finding future business champions, Warren Buffett and Charlie Munger have really excelled over the past seven decades. Q3 2021 hedge fund letters, conferences and more One could argue that these two individuals are some of the best growth investors of all time, thanks to their ability to spot companies like Coca-Cola Read More
Over the years, I’ve published 13 lists of low-debt recommendations. The average 12-month return on them has been 33.6 percent, although none has been that high since the financial crisis of 2007-09. By comparison, the average 12-month return on the S&P for the same periods has been 8.6 percent.
Twelve of the 13 lists have been profitable, and 11 have beaten the S&P 500.
Last year’s list scored a narrow victory over the S&P, with a 4.8 percent return versus 0.3 percent for the index. Yet three of the five stocks I recommended last year fell. My bacon was saved by an 86 percent gain in MGP Ingredients Inc. (MGP), which makes whiskey, gin and food ingredients.
Bear in mind that results for my column picks are theoretical and don’t reflect actual trades, trading costs or taxes. The record of my column selections shouldn’t be confused with the performance I achieve for clients. And past performance doesn’t predict future results.
Low-Debt Recommendations – Michael Kors Holdings
This year, I’ll start my low-debt stock recommendations with Michael Kors Holdings Ltd., which makes handbags, other leather accessories, shoes and clothing. The company is based in London but trades in the United States under the symbol KORS. Its debt is less than 1 percent of stockholders’ equity.
Kors has been growing rapidly both in sales and earnings. And it seems to be spreading its message effectively. When I worked in Boston, its ads greeted me every morning as I emerged from the subway.
The company is working toward the goal of having 400 stores in the United States, 200 in Europe and 100 in Japan. In the United States, about two-thirds of its stores sell the goods at full price. The rest are outlet stores.
Analysts don’t believe Kors can maintain its success. About two-thirds of the 30 analysts who cover the company rate it a “hold.” I disagree. I think this stock is a value at the present price of about $51, which amounts to 12 times earnings.
Taro Pharmaceutical Industries Ltd. (TARO) of Haifa Bay, Israel, is a drug company whose strongest suit is creams and ointments for dermatological use. It has shown a profit in 14 of the past 15 years, and its return on stockholders’ equity last year was very strong, at 38 percent.
Israel is a country under constant threat, and its stock market is volatile. Those factors are among the reasons Taro stock fetches only 10 times earnings, even though its sales have been growing at a 19 percent clip the past five years and it is debt-free.
The largest manufacturers of recreational vehicles in the United States, Thor Industries Inc. (THO), based in Elkhart, Ind., has debt equal to less than 1 percent of stockholders’ equity. It makes Airstream trailers and more than three dozen other brands of trailers and motor homes. It has shown a profit every year since 1980.
All streaks eventually end, but I don’t expect Thor’s to end soon. I believe that oil prices are likely to stay in the $40 to $60 range for a year or two, keeping gasoline affordable. In its latest 12 months, Thor posted a return on equity of 21 percent, the best it has done since 2006.
If your bread-and-butter activity is writing homeowners insurance and flood insurance in Florida, you are naturally prone to bad years when hurricanes hit. I believe that’s one reason Federated National Holding Co. (FNHC), a property and casualty insurer based in Sunrise, Fla., sells for only seven times earnings.
Investors are right to be skeptical, in that Federated did lose money in six of the past 15 years. However, its profits don’t correlate well with hurricane frequency. The company has been profitable since 2012, and I believe it has improved its pricing and efficiency. Debt is less than 2 percent of equity.
My final recommendation, Hibbett Sports Inc. (HIBB) of Birmingham, Ala., makes me nervous. There is a big short position in the stock (a lot of people betting that it will decline). Shorts often do thorough research and have good reason for their stance.
However, I think the shorts may be wrong in this case. A number of over-leveraged sporting goods stores have had to declare bankruptcy in the past year or so, but Hibbett has an extremely strong balance sheet, with debt less than 2 percent of equity. It has shown a profit in each of the past 15 years, and earned 22 percent on equity in the past four quarters.
Disclosure: I do not personally own the stocks discussed in today’s column. I own Thor shares for one of my clients.