Graham & Buffett: Six value ideas

by J. Royden Ward, editor Cabot Benjamin Graham Value Letter

Benjamin Graham has been recognized for decades as the father of value investing. Warren Buffett was his student and later worked for Mr. Graham for several years.

For this Special Report, we combine Buffett’s and Graham’s criteria for choosing stocks. We believe these six stocks sell at sensible prices, offer reasonable appreciation potential and provide solid dividends.

During the past six and one half years, we have included 13 Special Feature sections recommending Graham-Buffett Stocks.

The performance of these recommendations has been excellent. Our conservative Graham-Buffett Special Feature stocks increased 24.6% during the past 6.5 years compared to an increase of 4.3% for the S&P 500.

We looked for stocks with:

1) Free cash flow more than $20 million
2) Net profit margin more than 15%
3) Return on equity more than 15%
4) Discounted cash fl ow value higher than current price
5) Market capitalization more than $1 billion
6) Standard & Poor’s rating of B+ or better
7) Positive earnings growth during the past fi ve years with no defi cits
8) Dividends currently paid

We screened our Benjamin-Graham Common Stock Database and found six high-quality companies that fit our criteria. We are confident these high-quality stocks will fare very well during the next six months.

Caterpillar (CAT) is the world’s largest manufacturer of earth-moving equipment. CAT machines are used in mining, logging and farming, and in the construction, petroleum and transportation industries.

Financial results for the second quarter were muted by parts shortages stemming from the disaster in Japan.

However, during the remainder of 2011 and well beyond, demand for Caterpillar equipment will be especially strong as a result of the need to replace aging construction equipment.

Demand for additional equipment to rebuild not only the devastated areas of Japan, but also extensive areas of the U.S. affected by recent tornadoes, floods and hurricanes will also increase.

In addition, highways, bridges, etc. in the U.S. and other developed countries are in dire need of refurbishing and improvement.

Finally, the rapid development of infrastructure in emerging countries such as Brazil, China and India provides a bright outlook for CAT for an extended period of time.

Coach (COH) is a designer, maker and marketer of high-quality leather goods for men and women.

Products are sold in department stores, specialty shops and the company’s own Coach stores. Coach expects to expand its retail space by 12% during the next 12 months including opening 30 new stores in China.

COH’s stock price slipped in August due to weak quarterly earnings brought about by closed stores in Japan and higher raw material prices.

We expect sales and EPS growth of 15% during the next 12 months and beyond. The current low stock price provides investors with a chance to buy Coach at a bargain price.

J.B. Hunt Transport Services (JBHT) provides diversified trucking and logistics services. The company carries truck-load freight throughout the U.S. and into portions of Canada and Mexico.

JBHT also provides transportation, storage and planning to companies such as Wal-Mart, under long-term contracts.

Hunt’s intermodal segment offers the trucking of freight in shipping containers from port to rail to customer location.

“Shore to door” reduces handling and long-distance trucking. Management is focused on aggressively increasing its long-term contract business and intermodal operations, which are considerably more profi table.

We expect revenues to rise 12% and EPS to increase 29% during the next 12 months.

McKesson (MCK) provides a wide range of services and products to independent pharmacies, retail chains and institutions in the U.S. and Canada.

Their services and products reduce costs and improve efficiency. The company operates two segments.

The first, Distribution Solutions, distributes ethical and proprietary drugs, surgical supplies and equipment, and health and beauty care products throughout North America.

The second segment, Technology Solutions, delivers clinical, fi nancial and management software solutions, pharmacy automation and outsourcing services.

To diversify, McKesson acquired U.S. Oncology, which is dedicated to cancer treatment and research, in December 2010, for $2.2 billion. McKesson’s sales will likely increase 6%, and EPS 17% during the next 12 months.

Ross Stores (ROST) operates 1,091 stores in 27 states and Guam featuring high-quality apparel, shoes, jewelry and home furnishings.

Ross is able to offer brand-name merchandise at 20% to 60% below department and specialty store prices by buying manufacturers’ cancelations and overruns.

The company keeps low in-store inventories to increase turnover and to reduce the need for discounts.

Consumers continue to seek Ross’s low-priced products during the current economic malaise. The company will enter Arkansas and Illinois with an initial 15 new stores.

These will jump-start Ross’s presence and provide noticeable growth in the near future. We forecast sales and earnings growth of 12% during the next 12 months.

Tupperware Brands (TUP) is a leading direct seller of beauty and household products marketed by an independent sales force of 2.6 million representatives.

In addition, the company sells its products through the Internet and television. Tupperware derives 86% of sales from foreign markets, including 56% from developing countries.

Sales in Asian countries, such as China and India, are booming because underemployed women are good sales reps and retail stores there are lacking.

Sales will rise 10% or more, and EPS will likely increase 21% during the next 12 months, boosted by strong sales in the U.S., Canada and emerging market countries.

Learn more about this financial newsletter at J. Royden Ward's Cabot Benjamin Graham Value Letter.