Finding Stocks to Fill Your Portfolio's Mid Year Needs
The end of July is fast approaching, and for Major League Baseball that means one of the most exciting periods of the season: the week or so leading up to the trading deadline. With more than half a season under their belts, contending teams have a good idea of what they have -- and what they lack. So each year they try to plug their holes by making trades before the July 31 deadline (after which new acquisitions are in many circumstances not eligible to play in the playoffs). Whether it be a middle-of-the-lineup power bat or a left-handed relief specialist, good teams try to find that missing piece or two that will turn them into great teams.
This year, the dealing has been fast and furious. The surprising Los Angeles Dodgers dealt for Miami infielder Hanley Ramirez, hoping the immensely talented but struggling slugger will return to form and add some pop to their lineup. The Detroit Tigers also snagged one of Miami's better players, pitcher Anibal Sanchez, in an effort to bolster their starting rotation. And the New York Yankees, trying to replace injured speedster Brett Gardner, traded for Seattle's 10-time All-Star outfielder Ichiro Suzuki.
In investing, of course there is no trade deadline. But with the 2012 "season" a little more than halfway over, it's a good time to take stock of what your portfolio has -- and what it lacks. Maybe your holdings aren't producing the type of dividend yields you expected; perhaps you could use a few stocks with better earnings growth; or maybe you're feeling like your portfolio has too much -- or too little -- risk. Whatever the case, it's always good to reassess where your portfolio stands, and make sure you're taking advantage of the best opportunities in the market. With that in mind, I thought I would use my Guru Strategies -- stock-picking approaches that are based on the strategies of investing greats like Benjamin Graham and Warren Buffett -- to find some stocks that fit specific needs right now.
Need: Dividend Yield
Stock: Royal Dutch Shell PLC ( RDS.A )
Yes, Europe continues to struggle with a massive debt problem and struggling economy, so it might seem risky to go with a Netherlands-based company. But this oil and gas giant ($213 billion market cap) is active in more than 80 countries around the world, giving it a pretty diverse source of revenues. It's also offering a dividend yield of 5.1%, despite paying out a lower portion of profits (40.6%) than it has historically (46.2%), indicating it has room to raise its payouts. The firm is a favorite of my Peter Lynch- and James O'Shaughnessy-based models.
To find attractively valued stocks, Lynch famously used the P/E-to-Growth ratio, adjusting the "growth" portion of the equation to include yield for slow-growing stocks like Shell, which has grown earnings per share at a 3.2% pace over the long-term (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate). Yield-adjusted P/E/Gs below 1.0 are acceptable to my Lynch-based model. When we divide Shell's 8.0 P/E by the sum of its growth rate (3.2%) and yield (5.1%), we get a yield-adjusted P/E/G of 0.96, indicating it's a good buy right now. Another reason the Lynch approach likes the stock: Shell's debt/equity ratio is less than 20%.
My O'Shaughnessy-based value model, meanwhile, targets large firms with strong cash flows and high dividend yields. Shell is plenty big enough, has $12.75 in cash flow per share (nearly nine times the market mean), and sports that 5.1% yield, so it makes the grade.
Need: Protection if the Economy Weakens
Stock: Big Lots Inc. ( BIG )
Ohio-based Big Lots ($2.5 billion market cap) offers brand-name closeout and bargain merchandise -- which is what many consumers have turned to in recent years, and what they'll likely continue to turn to if the economy weakens.
Big Lots is another favorite of my Lynch- and O'Shaughnessy-based models. The Lynch approach likes its very reasonable 13.5 P/E ratio and stellar 20.03% long-term growth rate, which make for a solid 0.67 P/E/G. It also likes Big Lots' lack of any long-term debt.
My O'Shaughnessy-based growth approach looks for firms that have upped EPS in each year of the past five-year period, which Big Lots has done. The model also looks for a key combination of variables: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Big Lots has a solid 12-month relative strength of 77, and its P/S ratio of just 0.48 comes in well below this model's 1.5 upper limit.
Need: Strong, Reliable Growth
Stock: LKQ Corporation ( LKQ )
Chicago-based LKQ is an auto part firm that offers a variety of original, aftermarket, and used parts and systems, with more than 450 locations in the U.S., Canada, and the U.K. That might not seem like a big growth business, but LKQ has upped EPS in every year of the past decade. Its growth rate has been about 28% over the long term, and it accelerated to about 35% over the past year, part of the reason my Martin Zweig-based growth model likes the stock. The Zweig-based approach also likes that EPS growth has been driven by sales growth (which is also about 28% over the long haul), and not one-time cost-cutting measures. Plus, for a company producing such strong, accelerating growth, LKQ's shares are reasonably priced, trading for 21.2 times trailing 12-month EPS.
Need: Risk, Upside Potential
Stock: Banco Bradesco SA ( BBD )
While I examined a safer play above, the odds are that given how fearful most investors are about the global economy, your portfolio is more likely tilted too far away from risk than it is toward risk. If that's the case and the economy surprises to the upside, you could be left lagging the market significantly.
This South American commercial bank ($51 billion market cap) has several factors that make it riskier (or at least, perceived to be riskier): It's from an emerging market, it's a financial, and its home country, Brazil, has seen growth slow significantly. But my John Neff-inspired model thinks it's worth a good look. This approach looks for stocks with P/E ratios that are 40% to 60% of the market P/E, and Bradesco's P/E of 10.1 fits the bill. Neff was a big believer in the importance of dividends, and he developed a valuation ratio called the total return/PE ratio. Essentially, it's the inverse of the yield-adjusted PEG -- the metric adds EPS growth to dividend yield and divides by the P/E. Neff wanted this to be double either the market average or industry average, and Bradesco's 1.56 total return/PE is well over twice the market average of 0.59.
I'm long RDS.A, BIG, and LKQ.