Give Me That Old Time Religion: Low Debt Stocks
Posted: May 05, 2020
May 4, 2020 (Maple Hill Syndicate) – I love low-debt stocks.
Companies with little or no debt have staying power when an unexpected emergency pops up — the current pandemic, for example. They almost never have to sell a promising division because they need cash. They may be able to launch new initiatives, make acquisitions, or increase dividends.
My affection for low debt hasn’t always helped my clients’ returns. There are years when junk companies with high debt thrive, usually because interest rates are falling, making their debt less burdensome. But I think that a low-debt approach helps more often than it hurts.
The history of this column bears out that point. From 1998 through 2019, I’ve written 17 columns on the benefits of low debt. The average 12-month return on my recommendations in those columns has been 25.6%, versus 9.1% for the Standard & Poor’s 500 Index.
My low-debt selections have been profitable 14 times out of 17, and have beaten the S&P 12 times.
Bear in mind that my column recommendations are hypothetical: They don’t reflect actual trades, trading costs or taxes. These results shouldn’t be confused with the performance of portfolios I manage for clients. Also, past performance doesn’t predict future returns.
Last year (May 6, 2019 through May 1, 2020) was one of the three unprofitable years for my low-debt picks. They declined 20.5%.
The reason isn’t hard to find. I selected two retailers – Foot Locker Inc. (FL) and Urban Outfitters Inc. (URBN). Retailers were slammed when the coronavirus epidemic closed malls nationwide. Foot Locker plummeted 54%, and Urban Outfitters fell 43%.
My other two choices from a year ago fared better. Skyworks Solutions Inc. (SWKS) returned 17%. Cal-Maine Foods Inc. dropped about 1%, but was fractionally ahead of the S&P 500, which declined 1.5%.
I continue to believe that the probabilities favor investing in low debt stocks. Here are five new ones that I recommend.
Cullen/Frost Bankers Inc. is a banking company based in San Antonio, Texas, and doing business throughout Texas.
It’s out of favor for two reasons. One is that banking stocks in general are suffering from low-interest-rate malaise. The other is that people associate the bank with energy lending, and the energy industry is on its knees.
As a Texas bank, Cullen/Frost does lend to oil-and-gas companies, but nowadays only about 11% of its loans are energy loans.
Cullen/Frost’s debt is only about 6% of stockholders’ equity (corporate net worth). The stock sells for about 10 times recent earnings. As with most companies, earnings are expected to fall in 2020.
Based in San Jose, California, Align Technology Inc. (ALGN) makes plastic oral appliances that can often substitute for traditional metal braces.
With elective medical procedures being postponed because of the pandemic, the company’s revenue has been dammed up. However, I anticipate that something resembling normal business will resume within a year.
In the five years before the Covid-19 outbreak, Align had grown its sales at 28% a year and earnings at 29%. Currently the stock sells for about nine times trailing earnings, in contrast to its normal multiple of about 38.
Speculative but interesting is Loral Space & Communications Inc. (LORL), which operates 16 communications satellites. It’s a feast-or-famine company, with nine profitable years and five loss years out of the past 14. Last year it earned 27% on stockholders’ equity, which is quite good.
Of interest to balance-sheet fans like me: Loral had $259 million in cash (as of December 31, 2019) and only about $1 million in debt. The stock sells for eight times recent earnings.
National Presto Industries Inc. (NPK), based in Eau Claire, Wisconsin, has one of the strangest product lines you’ll find – small household appliances and military ammunition.
It’s an odd mix, but National Presto has been profitable in each of the past 15 years, even the horrible 2008. If you buy it, you’re buying steadiness rather than growth, as sales and earnings haven’t grown in the past decade.
Debt is only 1% of equity, and the company has about $45 in cash for every dollar of debt.
From last year’s list I will bring back Skyworks Solutions, which makes radio-frequency chips and other chips used in mobile communications. One knock on the company is that it’s too dependent on Apple Inc. (AAPL), but I regard that as more a blessing than a curse, since I think highly of Apple.
Making earnings estimates when the economy is in chaos is a precarious practice. But if analysts are guessing right, Skyworks sells for about 17 times 2020 earnings – not so bad for a company that has grown its earnings at a 13% clip the past five years.
Disclosure: I own Apple shares personally and for most of my clients. One or more of my clients owns Foot Locker and Skyworks Solutions.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at firstname.lastname@example.org.