My world according to GARP

John Dorfman
| Tuesday, Nov. 27, 2012, 12:01 a.m.

My personal Thanksgiving tradition is to recommend a few GARP stocks in late November. I've done it almost every year since 1998.

GARP stands for growth at a reasonable price. Normally, I won't pay more than 15 times earnings for a stock. But at Thanksgiving time I let my belt out a little, and recommend a few stocks selling for 15 to 20 times earnings.

The servings have been fairly tasty. In 11 outings, my GARP picks have shown an average 12-month return of 13.5 percent, compared to a return of 5.8 percent for the Standard & Poor's 500 Index over the same 11 periods.

My GARP selections have been profitable seven times out of 11 and have beaten the S&P 500 eight times out of 11.

Bear in mind that past performance doesn't guarantee future results. Results of my column recommendations should not be confused with the performance of portfolios I run for clients. And the column results are hypothetical, with no allowance for trading costs or taxes.

Last year's list was up a respectable 12.6 percent. But it trailed behind the S&P, which returned 19.7 percent (including dividends) from Nov. 22, 2011, through Nov. 21, 2012. The best performer was Union Pacific Corp., up 25 percent. The worst was Bed Bath & Beyond Inc., up 0.6 percent.

There's a continuum in stock investing. The progression is: distressed, value, GARP, and growth.

Distressed companies are losing money. Sometimes they are in danger of bankruptcy or emerging from bankruptcy. Value companies are generally profitable, but their stocks are cheap because of some real or perceived problem.

Growth companies have rapidly growing sales and earnings — or at least investors anticipate that they will. Accordingly, growth stocks usually sell for high multiples of revenue and earnings.

GARP companies occupy the territory between value and growth. Investors expect their sales and earnings to grow, but there are uncertainties that cause the stocks to sell for multiples are in the middle range.

Now for my 12th almost-annual GARP list. (It's almost annual because I forgot to do it in 2003, and was temporarily retired as a columnist in 2007 and 2008.)

This year, we'll begin with Schlumberger Inc. of Houston, Texas. Schlumberger was a pioneer in wireline operations, the art of using mechanical and electronic means to determine the extent and location of petroleum deposits in a well reservoir.

It is still the leader in wireline, and also provides a variety of other technically advanced help to drillers.

Last year, Schlumberger's return on stockholders' equity was about 16 percent. That would be good for most companies, but Schlumberger has broken the 30 percent barrier four times in the past decade. In the past 10 years the stock has sold for an average of 27 times earnings. Today it can be bought for 16 times earnings — and I recommend GARP investors do just that.

Tiffany & Co., the jewelry chain, is likely to break last year's earnings record of $3.40 per share this year. It has grown earnings at a 12 percent pace the past five years, even though those years included a particularly nasty recession in 2007-2009.

Discount stores have had a field day the past five years. I think high-end stores such as Tiffany may do better in the next few years.

Steven Madden Ltd. cashes in on women's never-ending love for high-fashion footwear. Its earnings declined — but never went negative — during the recession. Now they are back on track for new highs.

Based in Long Island City, New York, Steven Madden has 104 of its own stores and also sells its shoes through department stores and other outlets. With a return on equity of 21 percent last year, and a 23 percent earnings growth rate the past five years, I think this stock is worth more than its recent valuation of 16 times earnings.

Finally, I recommend Cheesecake Factory Inc. of Calabasas Hills, Calif. An unusually wide menu, large portions, high quality for a chain restaurant and relatively high prices are some of its hallmarks.

As with Steven Madden, Cheesecake Factory's earnings stayed positive during the recession of 2007-09. But it took five years for CAKE's earnings to regain their 2005 level. Now they are at a new peak, and analysts look for a 16 percent earnings gain this year and 13 percent growth next year.

Cheesecake Factory shares sell for 18 times earnings, which is more than I normally pay but less rich than some of their desserts.

John Dorfman is chairman of Thunderstorm Capital in Boston; jdorfman@thunderstormcapital.

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