By J. Royden Ward, Editor of Cabot Benjamin Graham Value Letter
From Cabot Wealth Advisory 11/22/10 Sign up for free Cabot Wealth Advisory e-newsletter
Twice a year, I combine Warren Buffett’s and Ben Graham’s criteria for choosing stocks for a special feature in Cabot Benjamin Graham Value Letter, the publication I edit. To find investment opportunities for you, I looked for stocks with:
1) Free cash flow of more than $20 million – cash needs include dividends, operating expenses, capital improvements and research.
2) Net profit margin more than 15% – a good indicator of growth sustainability.
3) Return on equity more than 15% – a barometer of future appreciation.
4) Discounted cash flow value higher than current price – Standard & Poor’s is a good source to find discounted cash flow estimates.
5) Market capitalization more than $1 billion – small companies not allowed.
6) Standard & Poor’s rating of B+ or better – indicates financial stability and steady growth of earnings and dividends.
7) Positive earnings growth during the past five years with no deficits – very important to adhere to.
8) Dividends currently paid – always important and helps your return, too.
I screened our Benjamin Graham Common Stock Database and found two high-quality companies that fit our criteria. Both companies, Microsoft and Oracle, are giants in the Information Technology sector, and both are producing impressive growth numbers.
Microsoft (MSFT) is the leading maker of software, primarily because of its dominance in desktop computer operating systems and office productivity products. The company’s Windows operating systems run more than 90% of all personal computers throughout the world. Microsoft’s server software products are used in 70% of all computer server systems.
Microsoft has two relatively new product lines. Cloud computing, which provides computing and storage on the Internet, is gaining in popularity, and the company has become one of the leaders. Video games have also become big business, and Microsoft has become a leader with its Xbox video game system and accessories. The company recently introduced Kinect to compete with the popular Wii and PlayStation Move games. Kinect is based on a webcam for the Xbox console and enables users to control and interact with the Xbox 360 without the need to touch a game controller. The player uses gestures and spoken commands to control a variety of games.
The software giant continues to spend heavily on research and development to maintain its front-running positions in the technology sector. Sales increased 25% and EPS soared 55% during the quarter ended 9/30/10—quite remarkable for a company with $65 billion in annual sales. Analysts are forecasting a sales gain of 9% for the next 12-month period and an increase of 11% for earnings per share. I believe Microsoft will produce substantially better growth during the next 12 months, which will drive its stock price considerably higher. MSFT shares are clearly undervalued at 10.2 times analysts’ forward 12-month earnings per share estimates. MSFT pays a decent dividend yielding 2.4% (which is about 10 times the amount paid by my bank on my savings account).
J. Royden Ward
Editor of Cabot Benjamin Graham Value Letter
A lifelong investment professional, J. Royden Ward applies his 40 years of investment research, portfolio management, writing and publishing experience to his role as analyst and editor of Cabot Benjamin Graham Value Letter, which is directed to long-term investors seeking a guide to profitable value investing based on the time-tested systems originally developed by Benjamin Graham, the Father of Value Investing. A second-generation disciple of Benjamin Graham, Roy in 1969 pioneered the development of a computerized model that applied the formulas developed by Graham using a unique ranking system. Today, Roy applies his system to two models in the Value Letter.
By Timothy Lutts, Chief Investment Strategist and Editor of Cabot Stock of the Month
For Cabot Wealth Advisory, 2/2/08 Sign up for free Cabot Wealth Advisory e-newsletter
Microsoft (MSFT) wants to pay $44 billion—perhaps the largest technology purchase ever—to buy Yahoo! (YHOO).
Why? To compete with Google!
But does it make sense? Well, from a big-picture point of view, anything that can thwart Google's dominance of Internet search and advertising probably makes sense for Microsoft, and if they've got the cash, there are worse places to spend it.
But does this make for an attractive investment opportunity? Do you want to own a piece of Microsoft/Yahoo!, recognizing that the Microsoft part is eight times the size of the Yahoo! part?
To find the answer, I put on two hats, one after the other.
With my growth hat on, I look at the pair and assume Microsoft will be the dominant partner. So I ignore the one-day chart strength of Yahoo! and note that Microsoft's chart is no stronger (or weaker) than the market. Since the end of 2000 it's been a market performer. And we want our investments to beat the market.
Fundamentally, I see annual revenue growth that has been under 20% in every one of the past eight years; the company is just too big to grow at the rates typical of growth stocks.
Finally, I see that while the number of mutual funds on board has shrunk from 1,722 back in 2004 to 1,248 at the end of the third quarter, that's still far too many holders; there are more potential sellers of this stock than buyers! It's undiscovered by nobody.
Conclusion: As Yoda might have said, "A growth stock Microsoft cannot be."
So then I put on my value hat and open up the latest issue of Cabot Benjamin Graham Value Letter. And there I find Microsoft, listed as one of the 250 highest-ranked stocks! This ranking is based on a complex combination of valuation, growth, consistency, technical strength and more. As of the end of January, Microsoft ranked high on quality, slightly above average on value and growth and very high on technicals. Added up, it achieved a rank of 8.99 on a scale of 10. And that's pretty good!
But it doesn't end there.
One of the greatest benefits of the Cabot Benjamin Graham Value Letter system is that it prevents you from overpaying for stocks. It sets Maximum Buy Prices for every stock and tells you never to pay more than that price for the stock. Thus it provides a Margin of Safety.
For Microsoft the Maximum Buy Price at the end of December was 31.06. The actual price of the stock back then was 35.52. But now the stock has fallen below 31, and patient investors who are in for the long term are welcome to buy it with my blessing.
But what's long term? How long do you hold? As long as it takes for the stock to hit its Minimum Sell Price, which in Microsoft's case is 46.76. Above that price, risk is excessive; when that price is hit, editor J. Royden Ward says you should sell and buy another stock that's undervalued.
If all goes well, Microsoft and Yahoo! will join together and make beautiful music and that Minimum Sell Price climbs as earnings grow.
But what if the deal goes through and the two companies have trouble working together? Well, by buying low, your downside risk is minimized (that Margin of Safety), so you can't lose much. And as a writer, I'll at least be glad that I no longer have to type that silly name with an exclamation mark at the end! The market’s rally continued this week, with all the major indexes scoring decent gains, including a powerful up day on Thursday. The Dow has now recovered a bit more than half of its December-through-January plunge. The S&P 500’s snapback has been a little less strong, recovering less than half, while the Nasdaq’s rebound has been even weaker.
By Timothy Lutts, Chief Investment Strategist and Editor of Cabot Stock of the Month
For Cabot Wealth Advisory, 3/24/08 Sign up for free Cabot Wealth Advisory e-newsletter
Back in 1905, George Santayana wrote, "Those who cannot remember the past are condemned to repeat it," a statement that has been paraphrased in numerous ways since. My high school history teacher, of course, appreciated the sentiment and tried to teach it to us. Yet of the entire year I spent in the man's class, what remains in my mind today is the fact that three times during the year, he pulled on the cord that unrolled the projector screen, only to have the entire assembly crash onto his head.
Some of us, I gathered, learn better from the past than others.
Which brings me to Microsoft (MSFT), which bid $45 billion to buy Yahoo! (YHOO) back on February 1.
My investment perspective on these companies is two-fold.
First, every investor in America knows these two companies. Microsoft is owned by 1279 mutual funds, while Yahoo! is owned by 480. Those are big numbers, and they tell me that there are more potential sellers than buyers for these stocks. They also tell me that there are thousands of analysts monitoring those companies. There is almost nothing that is unknown about those companies in the investment community and almost nothing that has not been imagined. And that means it's going to be very hard to beat the market by investing in those companies.
Second—and this was actually put into words by my father—those companies are going down the same road traveled by IBM decades ago.
(This is where knowing the past comes in handy. It means you're not condemned!)
Admittedly, IBM is a great company; it's been a great company most of my life. But the time to sell the stock was 1969, nearly 40 years ago. That's when IBM's stock stopped beating the market. Sure, the stock is higher now than it was then, but as an investor, you would have done better in an index fund.
And so it is with Microsoft and Yahoo! Their stocks have been lagging the market since the 2000 market top and there's very little chance either one will significantly outperform the market in the future.
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Timothy Lutts
President, Chief Investment Strategist, Editor of Cabot Stock of the Month
Timothy Lutts heads one of America’s most respected independent investment advisory services, publishing eight newsletters to more than 165,000 subscribers around the world. Tim leads a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems. Under his leadership, Cabot has been honored numerous times by both Timer Digest and the Hulbert Financial Digest as among the top investment newsletters in the industry. Tim also edits Cabot Stock of the Month.