Photograph by Michael Dziedzic
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The financial markets are reeling—and investors are reeling with them. Slammed by generational volatility, many stocks look like bargains. But who can stomach jumping into the water when the waves are pushing the stock-market seas up and down 5% or more each day?
Picking winners and losers in this environment might feel like a fool’s errand. But starting to sort through the sea of opportunity is a wise idea. To help stay engaged in this market, investors should embrace the power of the stock screen to find names with the right mix of factors for this moment.
Even in good times, stock screens are one of the most useful tools an investor has. They can yield a funnel of new ideas, even if one shouldn’t buy a stock based on a screen alone. In calmer times, some investors look for faster-than-average growth, while others favor cheaper-than-average valuation multiples. In the Covid-19 storm, traditional screens look inadequate.
Screening for multiple factors simultaneously will help. Using a mix is a little like two-factor authentication, which made the digital world far safer. As many remote workers can already attest, users enter passwords and then get texts or emails with confirmation codes. It reduces the chances for nasty surprises, such as identity theft.
For our multifactor stock-authentication screen, we settled on a combination of cash flow, debt, earnings growth, and valuation. That would help us get rid of bargain stocks that were cheap for a reason, or avoid paying through the nose for fortress balance sheets.
As a proxy for cash-flow stability, we looked for
S&P 500
companies that generated positive free cash flow in 2008 and 2009—during the financial crisis. Cash generating ability is at a premium again as Covid-19 dramatically slows the economy. We then kept only the companies with below-average debt and an absence of large, near-term debt maturities. Finally, we kept only those with below-average valuations and a demonstrated ability to grow earnings. In other words, we wanted a history of growth at a reasonable price.
About 40 companies made the cut. Turning a stock screen into stock selection is more art than science. We took the relatively more attractive stocks across many sectors, and we looked for any additional catalysts that might boost stock performance down the road.
Our final 12, in no particular order:
Caterpillar
(CAT),
Merck
(MRK),
UnitedHealth
(UNH),
Intel
(INTC),
Honeywell International
(HON),
Best Buy
(BBY),
W.W. Grainger
(GWW),
D.R. Horton
(DHI),
Qualcomm
(QCOM),
Akamai Technologies
(AKAM),
Lockheed Martin
(LMT),
BlackRock
(BLK).
The dozen are down about 18% year to date, a little better than the drop of the
Dow Jones Industrial Average.
They have little debt, on average, and trade at a 25% discount to their own valuation history.
And each has a story. Caterpillar makes diggers and dump trucks and bulldozers, huge machines ordered months in advance. It’s what is known as a long-cycle industrial business. Bank of America analyst Ross Gilardi cut his 2020 Cat earnings estimates Friday—the virus impacts everyone—but he noted the company had a strong balance sheet and a 4% dividend yield.
Grainger is an industrial distributor, selling lots of small-ticket items that turn over quickly. The company, historically, has generated growth and cash flow in most economic environments, in part because it can swiftly scale operations up or down, depending on demand. It also sells a lot of safety products, like masks and cleaning solutions—items in high demand today. The stock trades for about 14 times estimated earnings, a discount to the broader market’s 15.8 times.
Lockheed Martin, a defense contractor, isn’t completely dependent on the health of the broader economy. And in the case of Merck and
UnitedHealth
—two health-care stocks—the emergence of Joe Biden as the Democratic front-runner has eliminated some of the political risk for the sector.
Yes, this time is different. In the past 80 years, we’ve faced wars, banking crises, and recessions. We haven’t dealt with a global pandemic that threatens to grind the global economy to a halt. But even now, opportunities are revealing themselves. Investors just need a place to start.
Write to Al Root at [email protected]
