Low P/E 'Robot' list posts profit

John Dorfman
| Tuesday, Jan. 1, 2013, 12:01 a.m.

My trusty “robot” made a profit in 2012 but didn't cover itself with glory. It looked a little bit like R2D2 in Star Wars after a rough encounter with imperial storm troopers.

What is this robot? It is a naïve stock selection model that, much to my satisfaction, has enjoyed considerable success during the past 14 years.

The robot selects stocks with unusually low price/earnings ratios. I started this low P/E outliers list back in 1999 to make a point — that investors could do a lot worse than to buy extremely unpopular stocks, those with very low P/E ratios.

Stocks advance by exceeding prevailing expectations. Low expectations (embodied in a low P/E ratio) are easier to exceed than high expectations.

During the past 14 years, these robotically picked stocks have returned, on average, 22.5 percent per year. The Standard & Poor's 500 Index has returned, on average, 4.5 percent.

Last year, the robot stocks returned 7.8 percent but trailed the S&P's 14.1 percent. The figures are total returns, including reinvested dividends, from Dec. 31, 2011, through Dec. 28, 2012.

In 14 outings, the low P/E outliers have been profitable 11 times and have beaten the S&P 500 nine times.

It should be emphasized that the record of my column recommendations shouldn't be confused with the performance of actual portfolios I run for clients. Column results are hypothetical and don't reflect trading costs or taxes. Also, past performance may not indicate future results.

The selection method for the Robot Portfolio is simple. I start with the universe of U.S. stocks with a market value of $500 million or more, knock out those with debt greater than stockholders' equity (to reduce risk), and eliminate those with losses in the trailing 12 months.

That usually leaves about 1,000 stocks to pick from. By computer, without exercising judgment, I then select the 10 stocks with the lowest ratio of stock price to the company's earnings over the past four quarters.

These are stocks that most people won't go near. They have obvious problems — otherwise, they wouldn't sell for bargain-basement multiples like three, four or five times earnings. The average stock trades at 14 times earnings.

I don't like all the stocks this paradigm singles out, by any means. But I have found this field to be fertile ground for investigation and have often bought stocks that came to my attention through this paradigm.

Last year, the most successful pick the robot made was Holly Frontier Corp. (HFC), a refiner. It rose 108 percent.

The biggest clunker in last year's batch was GT Advanced Technologies Inc. (GTAT), which makes furnaces for producing purified silicon (for computer chips and solar panels) and furnaces for producing artificial sapphires. It ran into a buzz saw of Chinese competition and fell 59 percent.

Here is the new Robot Portfolio for 2013, based on prices and ratios as of Dec. 28, 2012.

The lowest P/E, three, belongs to Best Buy Co. (BBY), which retails consumer electronics. Critics say it has become a mere showroom for merchandise that people buy online from others. I think that Best Buy has a viable business, especially since competitor Circuit City bit the dust in the financial crisis.

Three qualifying companies have P/E ratios of four: Tronox Ltd. (TROX), which produces titanium dioxide pigments; Bridgepoint Education Inc. (BPI), which runs for-profit colleges; and Krispy Kreme Doughnuts Inc. (KKD). My favorite among these three is Krispy Kreme, which I like partly because it is run by a friend, Jim Morgan.

The remaining members of the robot list for 2013 all have P/E ratios of five. My favorite is Western Digital Corp. (WDC), a disk drive maker that I own personally and for clients. Another one that I own is Kulicke & Soffa Industries Inc. (KLIC), which makes semiconductor equipment such as die bonding systems and wafer saws.

Nacco Industries Inc. (NC) makes forklift trucks and small appliances (Hamilton Beach and Proctor-Silex brands). It owns a small coal company. I don't own it, but have recommended it from time to time in this column.

Completing the list are Assurant Inc. (AIZ), an issuer of health, disability, dental and credit insurance; Western Refining Inc. (WNR), which produces gasoline and other refined products sold mainly in Arizona, Texas and New Mexico; and C&J Energy Services Inc. (CJES), an oil service company that specializes in hydraulic fracturing, or fracking.

I will climb out on a limb and predict that this year's robot selections will beat the S&P 500.

John Dorfman is chairman of Thunderstorm Capital in Boston and a syndicated columnist; jdorfman@thunderstormcapital.com.

Subscribe today! Click here for our subscription offers.


Show commenting policy