John Neff’s GYP Ratio Makes the Case for These 5 Dividend Stocks
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
John Neff was an investing genius who viewed himself as “a low price-to-earnings investor.” During his 31-year tenure at Vanguard's Windsor Fund, Neff was producing annual total returns of 13.7%, on average, easily outperforming the market’s returns over the same time horizon. He followed an investment approach of picking undervalued stocks with reasonable earnings growth that were trading at earnings multiples between 40% and 60% below the valuation of the broader market. His investments were stocks that traded at low valuation multiples relative to their total returns as measured by the sum of forecasted earnings growth and dividend yield. Neff pursued stocks with a strong fundamental case for investment, earnings growth above 7%, and above-market total returns in relation to P/E ratios (i.e. the above-market GYP ratio).
What is the GYP ratio?
Today, the number of stocks that meet Neff’s strict selection criteria is small, just like many strategies with market-beating potential. Based on the GYP ratio (forward earnings growth rate, plus forward dividend yield, divided by forward P/E), we've found five stocks that seem undervalued when compared to the GYP ratio of the overall market. Neff’s attention to dividends stemmed from his belief that dividends were often overlooked and could help investors outperform the market.
American Railcar Industries (NASDAQ: ARII), a leading North American manufacturer of hopper and tank railcars, has a GYP ratio of 2.5, a result of a forward EPS growth rate of 17.4%, forward dividend yield of 2.9%, and forward P/E of 8.1. The company’s long-term EPS CAGR is 15.0%. American Railcar’s GYP ratio is 2.7 times higher than the comparable ratio for the S&P 500. The company’s payout ratio is 29% of the current-year EPS estimate.
We like American Railcar’s exposure to the booming energy sector and the long-term investment in railroad transportation as the most cost-efficient transportation means, particularly in the periods of rising energy prices. American Railcar is in a growth phase, coming out of 2012 as its best earnings year in history, which prompted the company to reinstate its dividend in the fourth quarter of 2012, after a pause of more than three years.
Its total revenues for 2012 were up 37%, driven by an increase in manufacturing segment revenues, while railcar shipments were up 51%. Revenue and EBITDA growth has continued into this year, driven by both manufacturing and leasing segment sales. Operating margins are improving year-over-year (holding at 16%), because of cost reduction initiatives from prior years. The company’s business model of a vertically integrated supply chain is resulting in savings.
We also like American Railcar’s long-term operational environment. Long-term replacement demand and growth will be driving demand for freight cars, both of which have favorable trend characteristics. The average age of covered hoppers is 20 years and the average age of tank railcars is 16 years. Tank car deliveries are expected to grow through 2014, and will average 15,300 units annually over the next five years, about the same, on average, as the number of covered hopper deliveries.
The company’s leasing operations are performing well and have a potential for notable growth in the future. American Railcar’s international expansion in India, and potentially in Russia, Saudi Arabia and Australia, could also boost financial performance in the future.
Ford (NYSE: F), the second largest U.S. automaker by market share, has a GYP ratio of 2.49, given its forward EPS growth rate of 18.6%, forward dividend yield of 2.7%, and forward P/E of 8.9. The company has a long-term EPS CAGR of 11%. Ford’s GYP ratio is thus 2.7 times higher than the comparable ratio for the S&P 500. While Ford’s long-term EPS CAGR is lower than that of its archrival General Motors and its forward P/E higher than GM’s, Ford differentiates itself with an attractive dividend. The carmaker’s dividend payout ratio is 29% of the current-year EPS estimate.
We like Ford’s long-term growth potential, despite near-term challenges in Europe and South America. Ford’s vehicle sales have been robust this year—rising 18% in April from the prior year, with the best April tally for pickup trucks since 2005. The U.S. energy sector boom, recovering construction markets, and the housing market have supported strong sales.
Long term, a pent-up replacement demand in the U.S. amidst a record-high average age of the passenger fleet will help drive U.S. vehicle sales for several years. The automaker is increasing its U.S. market share, but it's still suffering losses in Europe. We expect it to break even in two years, following its aggressive restructuring plan. We like Ford’s push to gain a competitive edge by shortening the length of its product cycle (to a three-year period) and introducing new models faster than competitors.
Herbalife (NYSE: HLF), a multilevel marketer of nutritional supplements and fitness products, has a GYP ratio of 1.98, which is a result of a forward (2014) EPS growth rate of 14.5%, forward dividend yield of 2.7%, and forward P/E of 8.7. Herbalife's long-term EPS CAGR is 15.1%. The company’s GYP ratio is 2.1 times higher than the comparable ratio for the S&P 500. Its dividend payout ratio is 25% of the company’s current-year EPS estimate.
This stock has been a focus of a contentious debate between hedge fund manager Bill Ackman of Pershing Square—who called Herbalife a pyramid scheme, initiating a large short position and financier Carl Icahn, who has built a respectable stake in the stock and has said that it may become “the mother of all short squeezes.” (He also thinks Herbalife is “a great company to take private.”)
Despite all this bologna, Herbalife has shown robust financial performance, reporting a year-over-year growth in net sales of 17%, 24% in adjusted EBITDA, 44% in adjusted EPS, and an adjusted operating margin expansion by 120 basis points to 17.2%. Its sales numbers show growth across all geographical regions and not just expansion in new markets.
Aside from the robust growth, the stock currently offers an attractive valuation. However, given the stock is at the epicenter of the clash of the hedge fund titans and a subject of highly speculative positions, it's better to wait until there's less speculation regarding its business model.
Textainer Group Holdings (NYSE: TGH), the world's largest lessor of intermodal containers based on fleet size, has a GYP ratio of 1.88, which is a result of a forward EPS growth rate of 11.7%, forward dividend yield of 4.8%, and forward P/E of 8.8. Textainer’s long-term EPS CAGR is 9.7%. The company’s GYP ratio is 2.1 times higher than the comparable ratio for the S&P 500. Its payout ratio is 48% of the company’s current-year EPS estimate.
The company controls 18% of the container leasing market. It has been profitable for 27 consecutive years and has paid dividends 24 years in a row. As an income stock, Textainer is attractive as its long-term leases provide secured and predictable revenue and cash flow streams. In fact, about 81% of its fleet is contracted on long-term and finance leases.
Its financial performance is strong, with a revenue CAGR of 17% and EBITDA CAGR of 24% since 2008. A remarkable sign of its financial resilience is its ability to sustain profitability during deep recessions, like in 2009, when the company’s operating margin dipped but remained a gaudy 35%. Since then, Textainer’s operating margin has climbed back over 50%.
The rest of the fundamentals are strong as demand for leased containers remains firm, average lease utilization is close to record levels at 95%, and residual values are attractive. The impending acceleration in global economic growth will lead to a further improvement in the company’s fundamentals.
Aircastle (NYSE: AYR), a company that acquires, leases and sells high-utility commercial jets, has a GYP ratio of 1.72, a result of a calculation based on a forward (2014) EPS growth rate of 11%, forward dividend yield of 4.2%, and forward P/E of 8.8. Aircastle’s long-term EPS CAGR is 24.4%. The company’s GYP ratio is nearly twice the GYP ratio for the S&P 500. Aircastle’s dividend payout ratio is 40% of the company’s current-year EPS estimate. The company has declared dividends for 28 consecutive quarters.
Aircastle's aircraft portfolio consists of some 159 aircraft on lease with 69 customers in 36 countries. The company is in a growth industry, and is projecting a total investment of $850 million or more to capture that growth. In fact, the company is planning to double plane leasing assets to $10 billion over the next five years.
We like that the long-term jet leasing market outlook is bullish, as Airbus forecasts a 4.7% CAGR in passenger traffic and a 4.9% CAGR in freight traffic over the next 20 years, which is above the pace of GDP growth. Especially robust will be growth in Asia-Pacific region.
Also positive is the fact that the company has a strong portfolio that is consistently almost fully utilized—portfolio utilization was 98%-to-99% and rental yield was 14% over the past six years. The company beat revenue and EPS estimates for the Q1 2013. It reported lease rental and financial lease revenues up 5%, reflecting benefits from new aircraft acquisitions, and adjusted EBITDA up 11%. Aircastle’s valuation also impresses, as the stock is trading at a 20% discount to book value.
There are many metrics out there that have beaten the market historically—see another one here—but we think the GYP ratio is underrated. Aircastle, Textainer, Herbalife, Ford and American Railcar may not have much in common from an operational standpoint, but their presence on John Neff’s screen makes them worth watching for the remainder of 2013 and beyond.
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This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Ford and Textainer Group. The Motley Fool owns shares of Ford and has the following options: Long Jan 2014 $50 Calls on Herbalife Ltd.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!