A Naïve Paradigm With An 18-Year Return of 1169%

John Dorfman

Over the past 18 years, my “Robot Portfolio” has achieved a cumulative return of 1169%, compared to 249% for the Standard & Poor’s 500 Index.

The works out to a compound annual return of 15.16%, versus 5.21% for the index.

My “robot” is just a naïve stock picking paradigm that selects extremely cheap stocks. It works like this:

  • Take all the U.S. stocks with a market value of $500 million or more.
  • Eliminate those that lost money in the past 12 months and those that have debt greater than stockholders’ equity.
  • Then simply choose the ten cheapest, as measured by the ratio of the stock price to the past four quarters’ earnings.

These are extremely out-of-favor stocks. The potential for gains is large, but so is the potential for losses. In the Robot’s two best years it made 97% in 2009 and 73% in 2013. But you’d need a lot of fortitude to stomach the two worst years, losses of 61% in 2008 and 31% in 2007.

Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.

Robot’s Record

I have been writing about the Robot Portfolio since 1999. It’s intended to illustrate my conviction that investing in cheap stocks, not popular ones, is the best road to stock-market profits.

I set the paradigm but a computer program picks the stocks. In recent years, I’ve been using a stock screening program from Ned Davis Research Inc.

In 18 annual trials, the Robot has shown a profit 14 times and beaten the S&P 500 Index 10 times.

Last year the paradigm showed a 4.11% profit but trailed the index, which advanced 11.96% including dividends. The best gainers were Greenbrier Companies Inc., up 31% and HP Inc., up 30%. Losers included PDL BioPharma Inc. (PDLI), down 38%, and Overseas Shipholding Group (OSG), down 34%.

Robot’s New Picks

Here are the 2017 selections from the Robot paradigm.

The cheapest stock, at three times earnings, is Atwood Oceanics Inc. (ATW), back on this list for a third straight year. Atwood is an offshore drilling specialist. I don’t expect offshore drillers to do well in 2017. Nevertheless, this stock is so cheap I think it might do okay.

Xenith Bankshares Inc. (XBKS), a bank based in Richmond, Virginia, is next cheapest at 3.7 times earnings. This bank has been shrinking in recent years but at the same time has become more profitable. Some insiders have been buying shares.

Career Education Corp. (CECO) weighs in at just 4.4 times earnings. For-profit colleges have been maligned for poor graduation rates, inferior job-placement rates, and a legacy of student debt. The Obama administration cracked down hard on these colleges. The Trump team is expected to be more lenient.

Baxter International Inc. (BAX) makes health care products, especially kidney therapies and hospital supplies. It was consistently very profitable from 2005 through 2014 but profits lately have become erratic. It now sells for just five times earnings.

Six More

Rowan Companies plc, out of Houston, is an offshore oil drilling company like Atwood, selling for five times earnings. My feelings on it are similar to what I said about Atwood.

First Solar Inc. (FSLR), based in Tempe, Arizona, is a leading supplier of solar power installations. President-elect Trump is expected to be less solar-friendly than President Obama was. But at 6.6 times earnings and 0.6 times book value (corporate net worth) this stock seems attractively cheap to me.

A small company making the Robot list this year is Farmer Bros. Co. (FARM) of Torrance, California, which makes and distributes coffee, tea, and food products. It sells for 6.6 times earnings, but a big portion of earnings last year consisted of income-tax adjustments.

Kelly Services Inc. (KELYA), a big temporary-help company, would seem to be in the wrong part of the economic cycle right now. As economic recoveries move along, employers usually hire more permanent workers and fewer temporary ones. Perhaps that’s why Kelly shares go for only 6.6 times earnings.

Back for a second year is Greenbrier Companies Inc. (GBX), a maker of railcars. After a good 2016 gain, it’s a little less cheap but I still like it a lot at 7.2 times earnings.

Until two months ago, ILG Inc. (ILG) was known as Interval Leisure Group Inc. The Miami, Florida, company operates vacation ownership resorts and time share resort properties. It has been profitable 13 years in a row but analysts expect profits to decline this year. The stock goes for 6.7 times earnings.

Disclosure: I own Greenbrier for a couple of clients.

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