Always on the hunt for the next great investor, Forbes magazine recently profiled Randolph McDuff, a virtually unknown online trader in Canada who has delivered gains of 32.2 percent a year for the past eight years.
That's almost three times more than Warren Buffett’s Berkshire Hathaway over the same time frame.
Like Buffett, McDuff is a value investor. But lacking Buffett’s ability to consistently find big winners, McDuff has adopted instead the style of Sir John Templeton. He seeks to identify a list of relatively inexpensive stocks.
Templeton, now 96, has been an investment superstar for more than six decades. He made his first investment gains by buying 100 shares of every stock selling for less than $1 a share at the beginning of World War II.
By the time the war ended, almost a third of the companies he had bought into were bankrupt. But his overall investment had returned more than 200 percent.
From there, Templeton went on to found one of the largest mutual fund companies in the world. Eventually he sold Templeton Funds to Franklin Resources, although he is still an active investor.
Known as a global investor, Templeton applies simple concepts to identify potential stock market winners. These factors were used to develop this Templeton value screen:
• P/E ratio less than the five year average P/E ratio for the stock and below the average ratio of all companies in the same industry.
• Earnings per share growing each year for the last five years and projected to increase in the current year. Additionally, the company needs to have forecasted earnings growth greater than the industry average.
• Operating profit margins better than industry average and showing steady improvement over the past five years. Operating margin is the ratio of operating income to sales. This is Templeton’s preferred measure of management quality. When a company's margin is increasing, it is earning more for each dollar of sales.
• Less debt than the industry average demonstrates to Templeton that the company is conservatively managed and likely to make money even in downturns. This is an important criterion for an investor who learned his craft during the Great Depression.
Ten companies passed the screen. I excluded Wall Street firms because of ongoing concerns associated with the subprime crisis:
Abercrombie & Fitch (ANF) A favorite clothing retailer for teens, ANF trades at only 12 times next year’s projected earnings. Management also delivers a return on equity of more than 30 percent, a number Buffett himself would consider impressive. Recently trading at 69.53.
Applied Industrial Technologies (AIT) Franklin Resources is among the largest holders of AIT, which offers a dividend yield of 2.1 percent at a recent price of 27.13.
Buffalo Wild Wings (BWLD) This company operates almost 500 Buffalo Wild Wings restaurants. Earnings are projected to grow about 25 percent a year over the next five years. The stock traded at 31.73 recently.
Expeditors International of Washington (EXPD) The fastest growing freight company, EXPD is trading near 43.57. Sequoia Fund holds nearly 5 percent of the outstanding shares. Sequoia has been cited as a great investment by Warren Buffett.
EZCORP (EZPW) An operator of check cashing businesses and pawn shops, EZPW has grown earnings at an average of 60 percent a year for the past five years. While this rate will slow in the future, it is priced at a bargain P/E ratio of 12 at the recent price of 13.78.
Fastenal (FAST) Another large holding of Sequoia Fund, FAST was recently priced at 47.88. FAST makes threaded fasteners — bolts, nuts, screws, and washers.
HEICO (HEI) Recently beaten down to a price of 37.81 on concerns about its industry, HEI has solid earning potential. The jet engine and aircraft component replacement parts maker is likely to continue beating analyst expectations, just as it has in the past.
Parker Hannifin (PH) Hydraulics are a boring business. But PH has turned it into a highly profitable one. Earnings of more than $5 a share over the last 12 months are undervalued by the market. At a recent price of 76.94, PH has a P/E ratio of 15 and a small dividend yield of 1.1 percent.
PetMed Express (PETS) Nearly everyone has seen a commercial for 1-800-PET-MEDS. Cash-strapped consumers are expected to turn to PETS to save money without skimping on care for their animals. At a recent price of 13.51, PETS trades with a P/E ratio below its earnings growth rate, making it a potential Peter Lynch ten-bagger in addition to a Templeton pick.
VCA Antech (WOOF) Another pet-focused company. WOOF runs 36 veterinary diagnostic laboratories and a network of 438 animal hospitals. Recently trading at 30, the stock has a P/E ratio of 21, which is justified based upon historical earnings growth.
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