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) and Amazon (AMZN). 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 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) 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). 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.