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December, 2014

FIFTEEN FOR 2015
by LARRY

Would you like the secret to getting 50% more than average for your equity dollars? Though the answer seems obvious, oddly enough most people invest in a less lucrative way. There is actually no mystery to better returns. Nor is obtaining them "rocket science." A few basic measures, these days readily available on the internet, can each help assure one substantially better than normal levels of investing returns. They have been known for several decades and since first found have worked year after year.


Five proven keys to equity investment best practices are contained in a compilation of research results, "What Has Worked in Investing," published by Tweedy Brown and Company a value investing mutual fund and money management firm. Its over 50 pages are packed with all a novice investor needs to become as good as, if not better than, a professional money manager.

The paper's findings show that each of the following factors can be critical in separating first-rate from merely mediocre stock market results:



1. Stocks that have gone down in price.

Markets are volatile, as are the prices of individual equities that comprise them. Performance can go up or down 50% or more in a single year and often does. One might think the best bets then are on those which have already had a good run. After all, everybody else is already getting on those bandwagons. They must therefore be headed in the correct direction, right? So, we could buy into stocks that are already up, hoping that more investors will keep piling on just like we did. That may work for awhile, yet sooner or later popular stocks will run out of steam. Per the research in Tweedy Brown and Company's report, in general a person would do better to buy stocks that have fallen in price than ones that have already risen significantly. In one study, for instance, NYSE assets which had performed worst in a prior 5-year period exceeded a market index by 18% over the first 17 months following the portfolio's inception.

Stocks Down in Price
CompanyTicker
Symbol
Recent
Price
52-Week
Decline
AngloGold Ashanti, ADSAU$8.6823%
Herbalife, Ltd.HLF$37.9053%
Oasis PetroleumOAS$16.2565%
(all table stats effective late 12/18/14)


2. Small-capitalization.

A lot of us feel more secure investing in large companies. They just seem more likely to do well and to at least avoid bankruptcy or going out of business. It turns out, though, that smaller publicly traded stocks have better average returns. The Tweedy Brown and Company research indicates that there is an indirect relationship between market capitalization (the price per share times the number of shares outstanding) and annual returns. Thus, the larger the stock's presence in the market , the worse returns it is likely to provide, and vice versa. One study, for example, showed that in the period 1963 to 1980 the smallest decile capitalization NYSE and AMEX stocks performed best, up over 32% a year through that period. Studies of foreign markets showed the same type result: low market capitalization stocks did the best in Japan, Australia, the United Kingdom, France, Canada, and Germany as well as over multiple investing periods. Stock performance of the lowest market capitalization stocks ranged from over 20% to over 80% annually in these overseas markets.

Small Market-Cap. Stocks
CompanyTicker
Symbol
Recent
Price
Market
Capitalization
Cimatron, Ltd.CIMT$8.73$94 million
Hurco Companies, Inc.HURC$33.46$196 million
Wayside Technology Group, Inc.WSTG$17.87$67 million


3. Higher than usual dividends.

Historically, 40% or more of the return from common stock investing has come from dividends. We tend to discount the value of dividends these days, when many companies do not provide any yield to shareholders and plenty of others have only a tiny dividend. The expectation is that companies that pay little or no dividend are investing their extra funds in good growth prospects. On average, the reality is often different. Upper management in so-called growth companies, that typically omit the dividends or keep them low, may use the additional money (that might have gone to the owners, stockholders) instead to pay themselves larger and larger salaries. They may go on buying binges, taking over smaller companies that have little of real value to contribute to the thus diluted enterprise. Alternatively, they may start other expensive projects that add only modestly if at all to companies' bottom lines. This sort of thing happens enough that companies that provide outsize dividends, without taking on too much debt, average better in overall returns vs. either average stocks or those that provide little or no dividends. One study, that included U.S. as well as foreign stocks over multiple years, found that the average excess over market index returns of stocks with initially the highest quartile dividend payments was about 6% a year.

Higher Than Average Dividends
CompanyTicker
Symbol
Recent
Price
Annual
Dividend
FutureFuel Corp.FF$12.853.80%
Sasol, Ltd.SSL$38.474.60%
Ternium, S.A.TX$17.564.50%


4. Low price to book value.

Book value, a company's assets per share less its liabilities per share, has been found also to be a profitable source of stock valuation. The ratio of price to book value, sometimes shortened to price to book or P/Bk, can suggest how great a bargain a stock is or the opposite. Low price to earnings is a similar measure, but earnings can be more easily fudged. There are generations' worth of research into results for low vs. high price to book value stocks. Enough info is out there that one can probably be safe simply buying low P/Bk assets, compared with average or high price to book stocks, and reliably gain better results accordingly. Often people do not find this to be true. The trick, though, may be first to select for low leverage stocks (those with little debt to equity, for instance, up to D/E of about 0.25) and then to know when to sell a stock bought for its good low P/Bk credentials (i.e. once its price to book value has risen to better than 1.0).

The Tweedy Brown and Company research, though, is clear: low P/Bk kicks butt. In a characteristic study, low price to book value stocks in the S&P 500 Index were compared with the S&P 500 Index itself over the difficult period from April 30,1970 to April 30,1981, a time which included arguably the worst post-World War II market meltdown till 2008. Stocks with P/Bk 0.5 and below provided average annual returns of 20% or better, while the S&P 500 Index averaged only single digit yearly returns. This measure of value is reliable enough, in my view, that when there are few un-leveraged low P/Bk stocks available from which to choose, as is the case these days, it is a sign that the market as a whole has gotten ahead of itself. We may then not be at the end of the game or even quite into the 9th inning, but savvy folks are starting to get restless and are looking toward the exits.

Despite this, I did find 3 stocks in this category that appear worth some of our investment dollars:

Low Price to Book Value Stocks
CompanyTicker
Symbol
Recent
Price
Price
to Book
Value
Kelly Services, Inc.KELYA$16.470.74
Petrobras Argentina, S.A.PZE$4.850.64
TransGlobe Energy Corp.TGA$3.260.44


5. Low price to cash flow.

Price to cash flow can be defined as the per share price divided by per share earnings net of taxes, preferred stock dividends, employee distributions, reported depreciation on fixed assets for the last known period, and misc. minority interests. That sounds rather complicated, but fortunately it is easy online to find this value, usually written merely as P/CF, on just about any stock in one of the U.S. exchanges. The lower the better, but stocks with P/CF of around 12 or below are generally considered to be in bargain territory. P/CF for stocks in our country tends to be high if over 20. P/CF varies by industry, though, and usually it is best to compare apples with apples and have relatively low P/CF in relation to other companies in the same sector. Nonetheless, there are a number of comprehensive, multi-year studies of P/CF in relation to returns. For example, all NYSE and Amex stocks were assessed in the period April, 1968, to April, 1990, and it was found that stocks in the lowest third by P/CF outperformed those in the highest third by about 8% a year. Annual total returns for stocks in the lowest P/CF decile were about 19%.

Low Price to Cash Flow Stocks
CompanyTicker
Symbol
Recent
Price
Price
to Cash
Flow
Adams Resources and Energy, Inc.AE$46.285.30
American Financial GroupAFG$60.0011.70
Unum GroupUNM$34.249.20


The search for a few good stocks in each of these five investing categories has led to 15 suggested candidates for 2015. Who knows what will be the investor's experience in 2015? Will it be a volatile 12 months? If I had to guess, I would say likely so. Will it also be a profitable one for those who stick it out? Odds support this. The third year of a U.S. presidential term is usually positive for our equities. In addition, years ending in 5 or 0, that are also third presidential term years, for some strange reason have been particularly good ones for stockholders. However, it seems foolish to stake much on such short-term speculations. An implication, however, of the Tweedy Brown and Company research would appear to be that one can be wrong about how any particular year will go and still come out considerably ahead of the game. Though past results do not guarantee future returns, most of the five-year results are decidedly positive (frequently with performance plus yield totaling 18-22% a year) for those who pick stocks that have fallen a lot in price before purchase, are low in market capitalization, have better than average dividends and low debt, are un-leveraged and low in price to book value, and/or have low initial price to cash flow.

Happy New Year, and good investing in 2015.



DISCLAIMER

Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)



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