Why I Relish Low-Debt Stocks
Posted: May 11, 2021
May 10, 2021 — (Maple Hill Syndicate) – When it comes to picking stocks, most investors go gaga over earnings, and pay little attention to a company’s financial strength.
I say that a strong financial position is far more important than whether a company “beat consensus” by ten cents a share in the latest quarter, or failed to beat it.
As evidence, I’d offer the history of my low-debt recommendations in this column. I’ve written 18 columns recommending stocks with low debt. The average 12-month gain on these recommendations has been 29.9%.
That dwarfs the average return for the Standard & Poor’s 500 Index over the same 18 periods, which was 11.3%.
Bear in mind that my column results 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 results.
Of the 18 sets of recommendations, 15 were profitable and 13 beat the index.
Last year, my low-debt stocks racked up a 102.9% return, versus 49% for the S&P. Align Technology Inc. (ALGN) led the pack, up 177%. Loral Space & Communications Inc. (LORL) chipped in 136%. Four of my five picks beat the index, the exception being National Presto Industries (NPK), which rose 34%.
Low debt does much more than reduce the chance of bankruptcy. It may allow a company to launch new projects, acquire troubled competitors, increase dividends or do stock buy-backs. All of those are usually good for the stock’s price.
Here are my next four low-debt picks.
T. Rowe Price
In an era when people have flocked to index funds, T. Rowe Price Group Inc. (TROW), a purveyor of traditional actively managed mutual funds, has done remarkably well.
In the latest quarter, the Baltimore-based company doubled its profit compared to a year ago, and increased its assets under management to a record $1.52 trillion.
This pleases me, because I think the craze for index funds is misguided. When you buy an index fund, you give up a chance of beating the market in exchange for (a) low fees, and (b) assuring that you won’t do much worse than the market. I think it’s a bad bargain, and I expect the popularity of index funds to begin declining in the next year or so.
A standard measure of profitability is return on stockholders’ equity (profits divided by a company’s net worth). I consider 15% good. T. Rowe Prices has topped that in each of the past 15 years, and exceeded 30% in the past three years.
Debt at T. Rowe Price is only 2% of stockholders’ equity (corporate net worth).
A debt-free choice is Logitech International SA (LOGI), headquartered in Lausanne, Switzerland. The company makes accessories for personal computers and smartphones, such as keyboard, mice, charging stands, webcams and Bluetooth speakers.
Logitech has increased its sales at a 16% annual clip the past five years, and even faster lately. It has no long-term or short-term debt, and holds $1.75 billion in cash or cash equivalents.
My only worry is that the stock may be a little too popular. It has been repeatedly recommended by Morgan Stanley, a leading brokerage house, and has climbed 124% in the past year.
You may have ethical objections to holding a gun manufacturer’s stock, and I respect that view. Nonetheless, on the numbers, Sturm Ruger & Co. (RGR) looks attractive.
Debt is only 1% of equity here. Return on equity was 32% last year, and has beaten my 15% yardstick 11 times out of the past 15 years.
President Biden has favored repealing a 2005 law that shields handgun manufacturers from lawsuits. I think fear of lawsuits is the reason Sturm Ruger sells for only 14 times earnings, despite its history of low debt and good profitability.
Covid testing gave Bio-Rad Laboratories Inc. (BIO) a boost in the past year. Investors and traders seem to figure this was a one-time shot in the arm, so to speak.
I figure that we are moving into a world in which more people will have more medical tests, more of the time. I believe that companies, schools and other institutions will gradually begin to require or incentivize tests, probably for Covid-19 and other health conditions as well.
Only in the past two years has Bio-Med met my return-on-equity yardstick. However, with the stock selling for only four times recent earnings, I think the risk-reward tradeoff is favorable.
Disclosure: I own Bio-Rad and Sturm Ruger for a couple of clients. I don’t personally own any of the stocks discussed today.
John Dorfman is chairman of Dorfman Value Investments LLC in Boston, 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.