4 midsummer stock buys

August downtime gives you an opportunity to review your holdings. Use these picks to plug holes in your portfolio.

By John Reese Aug 6, 2012 8:38AM

With the summer now more than half over and perhaps some August downtime approaching, this is a good time to reassess where your portfolio stands and make sure you're taking advantage of the best opportunities in the market.

 

With that in mind, I thought I would use my Validea.com Guru Strategies -- stock-picking approaches that are based on the strategies of investing greats like Benjamin Graham and Warren Buffett -- to find some stocks that fit specific needs right now.


Need: Dividend Yield

Stock: Royal Dutch Shell PLC (RDS.A)

Yes, Europe continues to struggle with a massive debt problem and weak economy, so it might seem risky to go with a Netherlands-based company. But this oil and gas giant ($213 billion market cap) is active in more than 80 countries around the world, giving it a pretty diverse source of revenues. It's also offering a dividend yield of 5.1%, despite paying out a lower portion of profits (40.6%) than it has historically (46.2%). That indicates it has room to raise its payouts. The firm is a favorite of my Peter Lynch- and James O'Shaughnessy-based models.

 

To find attractively valued stocks, Lynch famously used the P/E-to-Growth ratio, adjusting the "growth" portion of the equation to include yield for slow-growing stocks like Shell, which has grown earnings per share at a 3.2% pace over the long-term (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate). Yield-adjusted P/E/Gs below 1.0 are acceptable to my Lynch-based model. When we divide Shell's 8.0 P/E by the sum of its growth rate (3.2%) and yield (5.1%), we get a yield-adjusted P/E/G of 0.96, indicating it's a good buy right now. Another reason the Lynch approach likes the stock: Shell's debt/equity ratio is less than 20%.

 

My O'Shaughnessy-based value model, meanwhile, targets large firms with strong cash flows and high dividend yields. Shell is plenty big enough, has $12.75 in cash flow per share (nearly nine times the market mean), and sports that 5.1% yield, so it makes the grade.

 

Need: Protection if the Economy Weakens

Stock: Big Lots Inc. (BIG)

Ohio-based Big Lots ($2.5 billion market cap) offers brand-name closeout and bargain merchandise -- which is what many consumers have turned to in recent years, and what they'll likely continue to turn to if the economy weakens.

 

Big Lots is another favorite of my Lynch- and O'Shaughnessy-based models. The Lynch approach likes its very reasonable 13.5 P/E ratio and stellar 20.03% long-term growth rate, which make for a solid 0.67 P/E/G. It also likes Big Lots' lack of any long-term debt.

 

My O'Shaughnessy-based growth approach looks for firms that have upped EPS in each year of the past five-year period, which Big Lots has done. The model also looks for a key combination of variables: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Big Lots has a solid 12-month relative strength of 77, and its P/S ratio of just 0.48 comes in well below this model's 1.5 upper limit.

 

Need: Strong, Reliable Growth
Stock: LKQ Corporation (LKQ)

Chicago-based LKQ is an auto parts firm that offers a variety of original, aftermarket and used parts and systems, with more than 450 locations in the U.S., Canada, and the U.K. That might not seem like a big growth business, but LKQ has upped EPS in every year of the past decade.

 

Its growth rate has been about 28% over the long term, and it accelerated to about 35% over the past year, part of the reason my Martin Zweig-based growth model likes the stock. The Zweig-based approach also likes that EPS growth has been driven by sales growth (which is also about 28% over the long haul), and not one-time cost-cutting measures. Plus, for a company producing such strong, accelerating growth, LKQ's shares are reasonably priced, trading for 21.2 times trailing 12-month EPS.                         

 

Need: Risk, Upside Potential
Stock: Credicorp Ltd. (BAP)

While I examined a safer play above, the odds are that given how fearful most investors are about the global economy, your portfolio is more likely tilted too far away from risk than it is toward risk. If that's the case and the economy surprises to the upside, you could be left lagging the market significantly.

 

This Peru-based firm ($9.4 billion market cap) is involved in a variety of financial endeavors, including commercial banking, insurance, and investment banking. It's been a very strong grower, increasing EPS at a 22.4% rate over the long term. But it still trades for just 12.9 times trailing 12-month earnings, likely because of concerns about slowdowns in some of the big Latin American countries. That makes for a stellar 0.58 P/E/G ratio, a big reason why it gets strong interest from my Lynch-based model. For financials, Lynch used the equity/assets ratio and return on assets rate, and the model I base on his writings uses targets of at least 5% for the former and 1% for the latter. At 10% and 2.33%, respectively, Credicorp easily passes both tests.

 

I'm long RDS.A, BIG, and LKQ.


John Reese is the founder and CEO of Validea Capital Management and Validea.com and the author of The Guru Investor: How to Beat the Market Using History's Best Investment Strategies.

 

Tags: BIGRDS
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