Join Kelley Wright LIVE at The MoneyShow San Francisco!
Join Kelley Wright LIVE at The MoneyShow San Francisco!
Deep Value Stocks for the Long Haul
10/05/2016 10:00 am EST
Kelley Wright looks beyond the short-term moves of the market to focus on buying high quality, value-priced, dividend-paying stocks. The editor of Investment Quality Trends explains his strategy and highlights his current favorite stocks for long-term investing.
Steve Halpern: Our guest today is one of the smartest men in the advisory industry, Kelley Wright, editor of Investment Quality Trends, one of the longest running and best performing newsletters in the industry. How are you doing today, Kelley?
Kelley Wright: I'm very well, Steven. Thank you for having me.
Steve Halpern: Now, the long-term success of your investment strategy hinges on dividends. Could you expand on that?
Kelley Wright: Certainly. You know Charles Henry Dow said that when investing in stocks that it was imperative for investors to establish price. Now, at first blush, when you look at that quote you think, well, you can establish price, you just need to look at the quote machine, but that's not what he was referring to.
What it was talking about was the proper price or what we call value, and what dividends do for us is it allows us to identify value because dividends tell you if a company is profitable, if their profitability is increasing.
Dividends are a great predictor of a stock price increase. They provide a floor of safety underneath a stock. Dividends are also a company policy. They must be voted on by the board of directors, and so, that gives you a degree of certainty in a very uncertain enterprise because as we all know there are no guarantees in stocks, but dividends provide some of these certainties for us because they're voted on every quarter and declared and paid every quarter.
Steve Halpern: And also unlike earnings, dividends actually come back to the shareholders in terms of actual value.
Kelley Wright: Exactly, exactly Steven. They are the most visible sign of return on investments which is really the goal of all investors is to earn a return on investments and nothing is more clear in those terms than are dividends.
Steve Halpern: Now at the upcoming Dallas MoneyShow, you'll be offering a workshop called “Stocks for the Long Haul”. Now investors today seem to increasingly get caught up in the short-term moves. Could you make the case for the benefits of a long-term approach?
Kelley Wright: Sure. You know, as a value-oriented service, we typically are buying stocks when they're unloved and unwanted by the vast majority of Wall Street firms and investors and that's necessary if you're going to acquire shares of companies when they offer the most value.
That's when they're prices are low but more importantly when their dividend yield is at its highest repetitive area over a very, very long period of time, so if you're going to be a value investor and you're going to look for stocks that offer great value, you're going to often be early to the table and it's going to take time for Wall Street and for the market to catch up with you.
In order for you to maximize your return on investments, to get the most benefit from dividends and dividend increases, it doesn't happen overnight, Steven.
You've got to get in, you've got to get in early, you've got to get in at a low price and a high yield, and then you just have to be patient and wait for all of that value to be express in the market.
Steve Halpern: Now as part of this overall strategy, you suggest buying what you call deep value stocks. Could you explain what matrix help you determine when stock qualifies as deep value?
Kelley Wright: Well, you know, Steven, you know us pretty well, and as you know we follow the dividend yield patterns of the stocks that meet our criteria for our “Select Blue Chips”, and those dividend yield patterns do allow us to understand when price and yield are at an attractive point for each individual company.
What we've also learned over the last several years is that to understand the economic value of a company, you need to dig down and look at some things like return on invested capital which is basically what it sounds like is for every dollar that the company puts into the business what is the return on that dollar.
We have found that companies that have a return on invested capital of at least 10% offer greater economic value, and then another indicator or matrix that I look at is something called free cash flow yield.
Well, free cash flow is really kind of an industry term that most normal people use for something called profits. What we do to get free cash flow yield is we look at the profits of the company, what's left over after everything has been paid and invested, etc.
Then you divide that number into what's called the enterprise value, what's the company actually worth on an economic basis as an enterprise.
Kind of think of it in terms like you would the P/E ratio -- price divided by earnings -- but what we do is we take a look at the free cash flow divided by the enterprise value and that gives you what's called a free cash flow yield, and so like return on invested capital, what we're looking for are companies that have a free cash flow yield in excess of 5%.
When you take those two metrics together what that tells you is that, number one, the dividend is going to be very safe and secure because the company is an earnings and profit machine, but these are things that you kind of have to dig down and look for and know where to find and know how to use.
And those will open up and reveal to you the deep value that's available in some of these companies and that's what want because when you get those types of companies when their price is low and their yield is high you're going to have a position that you're probably going to hold for a very long time as all of that deep value is expressed through the price and through the market.
Steve Halpern: Now I know at the upcoming at Dallas MoneyShow, you're going to go in-depth into a wide variety of stocks that fall into this value category, but for those of our listeners who won't be able to attend, perhaps you'd be kind of enough to walk us through a few ideas on that figure criteria for long-term value.
Kelley Wright: Oh certainly. Sure, Steven. You know obviously you want to see a consistent pattern of earnings and dividend growth. We're looking for institutional sponsorship, companies, institutions that we want to get in first, but then we want them to recognize it and then help us rise our boat.
We're looking for stocks that offer liquidity meaning they have a sufficient float of shares available for buys and sells. We're looking for companies that have had uninterrupted dividend payments for 25 years, and we're looking for companies that have an S&P earnings and quality ranking of at least A- or better, so those are kind of the parameters that we look for for quality.
Then as I mentioned previously, then we identify what the repetitive patterns of high and low dividend yield are, and so we want to find these companies that meet our criteria, when their price is low and their yield is high, and then lastly, we're looking for those return on invested capital and free cash flow yield numbers. It's hard work.
There are 15,000 publicly traded stocks. There are only 237 that we follow in the newsletter, and right now, there are probably only about 25 to 30 of those 237 that fall into that category that are eligible for what we would call buying. It's hard work, but if you do the hard work and you take the time, the results are fantastic.
Steve Halpern: I wonder if I could get you to share a few names just to give our listeners a better idea of the types of stocks that meet this criteria?
Kelley Wright: Oh, oh sure, and it's kind of an interesting, varied list in terms of industry and things like that. There's like Franklin Resources (BEN), which is the Franklin Templeton Mutual Fund company.
Let's see here, Cummins (CMI), big industrial stock. It's a huge industrial stock. So, let me see, there's one other one on here that I would probably point to, Trinity Industries (TRN) which makes railcars and cargo containers.
Steve Halpern: Again, our guest is Kelley Wright of Investment Quality Trends. It's always fascinating to hear your thoughts. Thank you so much for your time today.
Kelley Wright: Oh, you're very gracious, Steven. It's my pleasure as always.
By Kelley Wright, Editor of Investment Quality Trends