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Why I Relish Low-Debt Stocks

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·4 min read
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- By John Dorfman

When it comes to picking stocks, most investors go gaga over earnings and pay little attention to a company's financial strength.

I say that a strong financial position is far more important than whether a company "beat consensus" by 10 cents a share in the latest quarter, or failed to beat it.

As evidence, I'd offer the history of my low-debt recommendations in this column. I've written 18 columns recommending stocks with low debt. The average 12-month gain on these recommendations has been 29.9%.


That dwarfs the average return for the Standard & Poor's 500 Index over the same 18 periods, which was 11.3%.

Bear in mind that my column results are hypothetical: They don't reflect actual trades, trading costs or taxes. These results shouldn't be confused with the performance of portfolios I manage for clients. Also, past performance doesn't predict future results.

Of the 18 sets of recommendations, 15 were profitable and 13 beat the index.

Last year, my low-debt stocks racked up a 102.9% return, versus 49% for the S&P. Align Technology Inc. (NASDAQ:ALGN) led the pack, up 177%. Loral Space & Communications Inc. (NASDAQ:LORL) chipped in 136%. Four of my five picks beat the index, the exception being National Presto Industries (NYSE:NPK), which rose 34%.

Low debt does much more than reduce the chance of bankruptcy. It may allow a company to launch new projects, acquire troubled competitors, increase dividends or do stock buybacks. All of those are usually good for the stock's price.

Here are my next four low-debt picks.

T. Rowe Price

In an era when people have flocked to index funds, T. Rowe Price Group Inc. (NASDAQ:TROW), a purveyor of traditional actively managed mutual funds, has done remarkably well.

In the latest quarter, the Baltimore-based company doubled its profit compared to a year ago and increased its assets under management to a record $1.52 trillion.

This pleases me, because I think the craze for index funds is misguided. When you buy an index fund, you give up a chance of beating the market in exchange for (a) low fees and (b) assuring that you won't do much worse than the market. I think it's a bad bargain, and I expect the popularity of index funds to begin declining in the next year or so.

A standard measure of profitability is return on stockholders' equity (profits divided by a company's net worth). I consider 15% good. T. Rowe Prices has topped that in each of the past 15 years, and exceeded 30% in the past three years.

Debt at T. Rowe Price is only 2% of stockholders' equity (corporate net worth).

Logitech

A debt-free choice is Logitech International SA (NASDAQ:LOGI), headquartered in Lausanne, Switzerland. The company makes accessories for personal computers and smartphones, such as keyboards, mice, charging stands, webcams and bluetooth speakers.

Logitech has increased its sales at a 16% annual clip the past five years, and even faster lately. It has no long-term or short-term debt, and holds $1.75 billion in cash or cash equivalents.

My only worry is that the stock may be a little too popular. It has been repeatedly recommended by Morgan Stanley, a leading brokerage house, and has climbed 124% in the past year.

Sturm Ruger

You may have ethical objections to holding a gun manufacturer's stock, and I respect that view. Nonetheless, on the numbers, Sturm Ruger & Co. (NYSE:RGR) looks attractive.

Debt is only 1% of equity here. Return on equity was 32% last year, and has beaten my 15% yardstick 11 times out of the past 15 years.

President Biden has favored repealing a 2005 law that shields handgun manufacturers from lawsuits. I think fear of lawsuits is the reason Sturm Ruger sells for only 14 times earnings, despite its history of low debt and good profitability.

Bio-Rad

Covid testing gave Bio-Rad Laborites Inc. (NYSE:BIO) a boost in the past year. Investors and traders seem to figure this was a one-time shot in the arm, so to speak.

I figure that we are moving into a world in which more people will have more medical tests, more of the time. I believe that companies, schools and other institutions will gradually being to require or incentivize tests, probably for Covid-19 and other health conditions as well.

Only in the past two years has Bio-Med met my return on equity yardstick. However, with the stock selling for only four times recent earnings, I think the risk-reward tradeoff is favorable.

Disclosure: I own Bio-Rad and Sturm Ruger for a couple of clients. I don't personally own any of the stocks discussed today.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at jdorfman@dorfmanvalue.com.

This article first appeared on GuruFocus.