2 Perfect Stocks — Yes, You Read That Right

by Tim Melvin | September 25, 2013 12:13 pm

As a long-term investor specializing in undervalued securities, I spend a lot of my time searching for the perfect stock. But my definition of “perfect stocks” may not be obvious.

Most people think a perfect stock is going up a lot right now; those tend to be the popular issues like Facebook (FB[1]) and Amazon (AMZN[2]). Because of their rapid ascent, those stocks are too richly priced for my taste.

My definition of a perfect stock is lifted from a presentation done by legendary investor Walter Schloss a few years back. A perfect stock is one that trades below book value, is profitable and has a manageable amount of debt on the balance sheet. The company also has enough insider ownership for the officers and directors to have a long-term vested interest in a higher stock price. As a final qualifier, I need for the company to pay a dividend. It doesn’t have to be much, but there needs to be some level of shareholder payout.

Most of the stocks on the list right now are smaller banks. I am fine with this outcome — I continue to think small banks are the single best sector for long-term investors[3] right now — but it also makes a statement about current valuation levels of the over stock market. This screen usually produces a 100 or so candidates; right now the total output is less than 30 names. (I will add that paucity to my growing collection of stock market red flags.)

MutualFirst Financial (MFSF[4]) makes the list, trading at 80% of book value and yielding 1.61%. The bank has total assets of about $1.4 billion and is located in Muncie, Ind. Like a lot of small banks today, the story here is one of steady credit improvement and compressed net interest margins. It is one of many smaller institutions that I think will eventually be taken over; the current regulatory climate simply does not favor little banks. Insiders own about 10% of the stock, so they are invested in the idea of a much higher stock price.

One of the more interesting nonbank stocks on the list is International Shipholding (ISH[5]). The company operates a fleet of U.S. and International flag vessels that provide transportation services to commercial and governmental customers, primarily under medium- to long-term charters. The fleet is widely diversified and includes several U.S.-flagged vessels that can carry freight from port to port inside the United States. The shipping industry is starting to recover, and this stock is very cheap at 80% of tangible book value. Insiders own 10% of the company and have done a good job of navigating the turbulent economy. The stock yield 3.8% at this level, so you’re getting paid to wait for the stock price to move higher.

Perfect stocks are best for patient, long-term investors — but they usually end up giving you a return that is multiples of your purchase price instead of just percentages.

At the time of publication, Melvin was long ISH and MFSF.

Endnotes:
  1. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  2. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  3. the single best sector for long-term investors: http://investorplace.com/2013/08/small-banks-are-the-trade-of-the-decade/
  4. MFSF: http://studio-5.financialcontent.com/investplace/quote?Symbol=MFSF
  5. ISH: http://studio-5.financialcontent.com/investplace/quote?Symbol=ISH

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