Cheapskate Portfolio Edges out the S&P 500
Posted: April 25, 2017
What would happen if every year you bought the cheapest stock in each of the major stock-market sectors?
I’ve been doing that for nine years –on paper, not with real money – and the results are interesting. My findings suggest you would do slightly better than the market over a one-year period, and considerably better if you hold for three years.
My experiment began in 2002-2006 and resumed in 2013 to the present. I call it the Cheapskate Portfolio.
The average three-year return has been 33.9%, versus 24.9% for the Standard & Poor’s 500.
The average one-year return has been 11.3%, against 10,5% for the index.
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.
The Paradox
Should you just go out and buy the cheapest stock in each sector? I wouldn’t do it mechanistically. But I think these stocks – unpopular by definition – deserve a look.
These company have obvious problems. And it’s the very obviousness of those problems that can create capital-gains potential. Management doesn’t have to make things perfect, just better than the market is expecting.
To be eligible for my annual list, a company must be based in the U.S., must be currently profitable, and must have debt less than stockholders’ equity (corporate net worth). It must also have a market value of $1 billion or more, and sell for 15 times earnings or less.
To determine the cheapest qualifying stock, I use the price/earnings ratio. That’s the stock price divided by the past four quarters’ per-share earnings.
Here is my latest crop.
Droopy Depot
In the consumer discretionary sector, the cheapest stock currently is Office Depot Inc. (ODP) at five times earnings. Stiff competition from internet retailers such as Amazon has hurt office supply stores. And the morale of Office Depot shareholders took a blow when the company’s proposed merger with Staples Inc. was blocked on antitrust grounds.
In consumer staples, the cheapness crown goes to Sanderson Farms Inc. (SAFM). Chicken farming is no picnic, with periodic poultry gluts and occasional bouts of avian flu. But the long-term trend for Americans to eat more chicken and less red meat continues.
In energy, the cheapie is Arch Coal Inc. (ARCH). Arch emerged from Chapter 11 bankruptcy in October 2016. Stockholders were wiped out and the stock in the “new” Arch went to the previous bondholders. As a result, the company’s current debt meets my guideline – but it’s clearly a high-risk pick.
Who bothers?
AmTrust Financial Services Inc. (AFSI) is the least expensive financial stock, going for less than eight times recent earnings. The New York based property & casualty insurer’s stock topped $32 in parts of 2015 but has been cut in half since, to $16. Not many analysts bother to follow it. Those few who do like it at current prices.
In health care, the low-P/E crown goes to Baxter International Inc. (BAX), which makes kidney-care and hospital supplies. It spun off most of its pharmaceutical business in 2015 as Baxalta, keeping the steady but less sexy businesses. One current issue is a criminal investigation into price-fixing in the saline solutions business.
Unloved in the industrial sector is Delta Air Lines Inc., (DAL). It sells for eight times earnings, despite good recent profitability. Clearly, investors doubt that the good times will roll on. The propellant of lower fuel prices may be largely spent.
eBay at Bay
Information technology is not an arena known for cheap stocks, but it has a few, most notably eBay Inc. (EBAY), the online marketplace, at five times earnings. EBay has turned a profit in each of the past 15 years, and often a handsome one. It seems undervalued to me.
In the materials realm, the nominee is Worthington Industries Inc. (WOR), a steel processor with headquarters in Columbus, Ohio. It has a P/E ratio of 13. There are cheaper stocks in the sector, but they violate my debt limit.
No U.S. stocks qualified in the telecommunications sector. AT&T Corp. (T) was the designee the past two years, but it sells for 19 times earnings at the moment.
Among utilities, Hawaiian Electric Industries Inc. (HE) just squeaked in, selling for just under 15 times earnings.
Disclosure: I own Sanderson Farms personally and for most of my clients.