Streetwise for Friday, December 8, 2017

You may have noticed the recent shift out of technology and into finance. One key reason is the tax overhaul being worked on my Congress that is nearing completion. Another is the likelihood of an increase in interest rates in December.

So, suddenly the technology sector is out of favor. However, if you are an alert investor you could possibly reap substantial future returns by seeking out those stocks that fit the description, “best of the worst”, although the connotation of worst is quite misleading.

Suddenly companies like Microsoft, Apple and Intel are out of favor, and yet they have done nothing out of the ordinary, or posted any sort of negative news. What you have is an excellent opportunity to buy when others are selling.

At any given moment in time, certain industry groups will be looked upon by Wall Street with kindness, while others are not so fortunate. However, if the stock market is anything, it is fickle.

Stocks that are discarded today could well be the glamour stocks of tomorrow. This particularly significant in December as many investors and portfolio managers engage in tax-loss selling.

Look carefully at the stocks in out-of-favor industries. Analyze carefully the earnings of any stock you might be interested in, being particularly cognizant if it might outperform in the future.

Quality stocks can be kept down because they are unfortunate enough to be part of a lagging industry group. The wheat is trampled along with the chaff. Thus, a commendable stock can be unduly stigmatized by the company it keeps.

Investors with more important fish to fry in the currently favored industries will usually ignore all stocks in an out-of-favor group. A smart investor will scrutinize the worst industry groups, looking for the best company in each group.

To accomplish this, you will need to utilize highly disciplined selection approach. There are several methodologies to which I attach considerable importance. One, which I mention continuously, is to utilize a selection criterion based on dividend history. Companies that continually raise their dividends for ten or more years tend to do well over time.

At the same time, dividends should represent less than 65 percent of earnings. Lean towards companies that payout 35 to 40 percent. This allows the company to reinvest, i.e., compound more of its profits for continued growth.

Another helpful tactic is to look for companies whose long-term debt that is less than 30 percent of their total capitalization. You might be fortunate enough to find some companies that have no long-term debt. Note, utility companies are an exception to both the dividend payout and long-term debt requirements.

You might also look for stocks with a price-earnings ratio, or P/E, that is in the lower half of its ten-year range, or below the P/E ratio for the Standard & Poor’s 500 index.

And of course, there is my favorite screen, the intrinsic value of a company using a model such as free cash flow to the firm. You can find an adaptation of this technique at ValuePro.net.

One or more of these screening methods will probably leave you with approximately 100 companies from which to select 10 to 15 candidates that merit serious attention; which brings up a critical point. Screening companies can be time-consuming, but it is just a mechanical process that nowadays is relegated to computers.

The difficult part is parsing out those that really merit study. Of course, you can tighten your screening criteria until only a few stocks are left, but this is generally not a satisfactory solution.

Moreover, the screening process is only the first step. From there you progress to a combined subjective/objective analysis of factors such as management and financial strength, franchise in the marketplace, and potential growth of future earnings and dividends. The depth of the analysis is up to you.

Finally, I suggest you pick stocks with the goal of keeping your turnover, i.e., the number of stocks you replace annually, to a minimum. A good number to shoot for is less than 10 percent.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.