3 Elegantly Appointed Retailers

12/07/2012 11:15 am EST


John Reese

Founder and CEO, Validea.com And Validea Capital Management

Sometimes it's the practical that is far more attractive than the extravagant, and this trio of retailers make that point abundantly clear when it comes to their stocks, writes John Reese of Validea Hot List.

Our approach is to buy stocks using investment models that are based on the strategies of longstanding experts.

Guess? (GES) earns a 100% score on our Benjamin Graham screen. Guess? designs, markets, distributes, and licenses apparel and accessories for men, women, and children.

To pass the Ben Graham value model, a stock's current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. GES's current ratio of 2.8 passes the test.

Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. Companies with this type of growth tend to be financially secure and have proven themselves over time. GES's EPS growth over that period of 2,964.3% passes the EPS growth test.

The Price/Earnings (P/E) ratio, based on the greater of the current P/E or the P/E using average earnings over the last three fiscal years, must be "moderate," which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. GES's P/E of 9.55 (using the current P/E) passes this test.

The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. GES's Price/Book ratio is 1.97, while the P/E is 9.55. GES passes the Price/Book test.

Ross Stores (ROST) earns a 91% score on our Peter Lynch-based model. The price-to-earnings growth model examines the P/E (18.84) relative to the growth rate (31.29%), based on the average of the three-, four-, and five-year historical EPS growth rates, for a company.

This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for ROST (0.60) makes it favorable. This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years.

This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for ROST is 31.3%, based on the average of the three-, four-, and five-year historical EPS growth rates, which is acceptable.

This methodology would consider the Debt/Equity ratio for ROST (9.01%) to be exceptionally low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.

Finally, The TJX Companies (TJX) earns a 90% score on our Kenneth Fisher model. Using this approach, a prospective company should have a low Price/Sales ratio. JX's P/S ratio of 1.25 based on trailing 12-month sales falls within the "good values" range for non-cyclical companies and is considered attractive.

Less debt equals less risk according to this methodology. TJX's Debt/Equity of 23.19% is acceptable, thus passing the test.

This methodology looks for companies that have an inflation-adjusted EPS growth rate greater than 15%. TJX's inflation-adjusted EPS growth rate of 19.15% passes the test.

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. TJX's free cash per share of 1.08 passes this criterion.

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. TJX, whose three year net profit margin averages 6.18%, passes this evaluation.

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