In Search of New Ideas
Stephen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors who are new to the game face a serious challenge right from the start. There are over 5,000 companies on just the NYSE and NASDAQ, and only a small fraction of them are big name companies a typical investor would be familiar with.
To make matters worse, the primary source of investing ideas for the individual investor, the financial media, focuses primarily on large cap companies or popular growth small caps. This should come as no surprise. Media outlets need to sell ads, and advertisers are interested in eyeballs and clicks. Articles that cover big name companies will attract significantly more readers than an article advocating a small cap regional bank that pays a dividend. Let me be clear that I'm not making a blanket statement regarding the quality of either as an investment. I include dividend aristocrats of the Dow Jones (DJINDICES: ^DJI) as part of my portfolio, but I also set aside a portion to invest in companies flying under the radar.
A stock screen is a handy tool for discovering new investment opportunities. It uses a set of criteria input by the user to find only those stocks that meet all of the requirements. A screen can be used to identify stocks for a specific strategy, such as large cap stocks with dividend yields >3%, or to find the company that perfectly matches what your favorite investing author considers the "perfect stock." Below are the criteria for a screen I ran to find some new small and mid cap companies.
Some investors dislike dividend yields in small caps because dividends take away cash from investment in growth. Dividends signal to me that management cares about shareholders, and I believe the financial discipline dividend payments force on management ultimately makes for stronger decision making. I want cash flow growth to be positive and for both 5-year and TTM sales growth to be above 10%. Return on equity is another measure of the effectiveness of management. Finally, I use the current ratio, debt to capital, and interest coverage to weed out small companies that are potentially overburdened with debt.
The first company to catch my eye was Sturm, Ruger & Co. (NYSE: RGR), the iconic firearm manufacturer. The stock has been on a tear, gaining nearly 150% over the last year; however it fell 25% over the painful month of May. Sales rose nearly 50% and EPS almost doubled during their most recent quarter. The company has zero debt, yields 3.5% and looks very interesting at 15 times earnings and 2 times sales. This year they have struggled with maintaining enough inventory to fulfill orders, but they recently announced the resumption of order taking. This company is definitely worth a deeper look.
CARBO Ceramics Inc. (NYSE: CRR) is a manufacturer of proppants used in hydraulic fracturing. This company is a great natural gas play, if you believe in the future of natural gas production in the United States. The company is in a great financial position with zero debt and over $100M in operating cash flow. Inside ownership is over 14%, a very positive indicator that management priorities are aligned with those of shareholders. Over the last few years the stock has been a roller coaster ride, strongly correlating with the performance of oil and natural gas drillers like Halliburton. These stocks have been punished as natural gas prices sit at historical lows, however, the winds may be shifting in favor of natural gas, and investors in these companies may stand to profit.
There is no shortage of investing ideas presented to the individual investor by the financial media. It's certainly not all bad advice, heck, most of it even may be good. But it is driven by what attracts viewers, listeners, or readers. There's more out there to discover, and a simple stock screen is a great way to begin the search. Don't kid yourself, though. We live in an information age, and even the most esoteric stocks receive some coverage. The purpose of this exercise is to create separation from the noise of the headlines and to find those companies that are quietly chugging along while creating shareholder value.
drfrank1 does not own shares in any of the companies mentioned in this entry. The Motley Fool owns shares of CARBO Ceramics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.