Beat the rush and use this screen to find beaten-down, but solid firms.
This article first appeared in the December 2010/January 2011 issue of Morningstar Advisor magazine. Get your free subscription today!
It's holiday time, and to go along with the bombardment of advertising, promotions, and articles about must-have toys, here's a screen that looks for attractive consumer-related investments.
With high unemployment and a weak housing market, it's easy to see why an investor's initial reaction might be to avoid consumer- dependent companies. We have yet to see significant and definitive signs of an economic recovery, and every economist has a different opinion on how long the weak economy will prevail. The uncertainty presents a good time to go shopping for bargains, and investors can pick up some high-quality companies at discounted prices.
(Sector = Consumer Services
Or Sector = Consumer Goods)
We start our screen by restricting our list to only consumer-services or consumer-goods stocks. This will leave us with more than just traditional consumer discretionary companies, it will also include everything from auto manufacturers to grocery stores.
And Total Return 1 Year < 0
Next, we look for stocks that have been laggards so far in 2010. Most stock indexes have posted middle- to high-single-digit returns, so stocks meeting our criteria will have underperformed by a meaningful amount. Buying stocks that are temporarily unloved or out of favor by the market can be very profitable; of course, this strategy assumes that the underlying business is still healthy and future prospects are attractive.
And Morningstar Rating > 3
We turn to Morningstar's equity analysts to make sure that we are finding good stocks, rather than stocks that are positioned to lag the market for years. Searching for stocks with Morningstar Ratings of 4 or 5 stars will only find stocks that Morningstar analysts think are attractively valued relative to the analysts' forecasts of the companies' future results.
And ROE % Rank Industry Year 1 < 50%
Although we are looking for companies with stock prices that have lagged, we want firms with strong business performance. By looking at returns on equity, we can find companies that are highly profitable and efficiently using their equityholders' money. This criteria required companies to have an ROE in the top half of all companies in its industry, ensuring that we are picking up high-quality businesses.
And PCF Ratio Current < 10
When looking for consumer stocks, it's important to avoid overpaying for a fad or a hot growth stock. The last thing we want in our portfolio is the next Crocs-like stock. Limiting our search to stocks with a price/ cash-flow ratio of less than 10 will help make sure we aren't paying too much of a premium for a hot stock.
This screen, performed in Morningstar Principia, leaves us with 12 companies (as of Oct. 19) across a variety of industries--everything from apparel stores to a NASCAR race track operator. Here are a handful that stand out.
We forecast 2010 revenue to be just slightly negative, as wholesale momentum continues to mitigate negative comparisons in the Payless domestic segment. After several years of inconsistent results, we expect gradual improvement in operating margins during the next few years and believe operating margins will come in above 5% during 2010. Gross margins should benefit from a more efficient supply chain and higher merchandise margins. We anticipate average operating margins in the low 6% range over the forecast period, reaching 6.7% in out years.
Toyota's other strength is its manufacturing expertise, which is so good that Ford
We expect International Speedway to have operating margins of 21% in five years, identical to its current operating margin and lower than the 28% average operating margins it's had over the past five years.
International Game Technology
We think that the firm will continue to experience weak top-line growth in the near term as the domestic replacement cycle is prolonged. However, we anticipate increased growth in later years as the replacement cycle commences and casino operators refresh their slot floors. Our seven-year compound annual growth rate is 11%. We expect operating margins to expand by about 12.5 percentage points (7 percentage points, excluding 2009 one-time charges) to 27.5% by 2015 as the company eliminates operational redundancies, resizes its cost structure, and increases profitability.
David Krempa is a stock analyst with Morningstar.