The Altman Z-score is one of my favorite measures of corporate financial strength to use when looking for safe stocks to buy. The test, which was developed by Professor Edward I. Altman of New York University’s Stern School of Business, uses five financial metrics to measure a given company’s ability to survive.
Companies that rate higher than 3.0 are considered safe with little real financial risk over the next few years. A score below 1.8 indicates a high risk of financial failure in the not-so-distant future.
Restricting our universe to stocks that have no indication that they’re are risking financial failure can help improve your returns; the Altman Z-score calculation allows investors to avoid companies running the risk of permanent loss of principal. And by using the Z-score in conjunction with the enterprise-value-to-EBITDA (EV/EBITDA) ratio — a metric favored by private-equity and leveraged-buyout investors — we can assemble a portfolio of undervalued stocks with low financial risk.
These astute buyers prefer to buy companies with an EV/EBITDA ratio lower than 5.0 times, so we will limit our universe to companies that trade with an EV/EBITDA ratio below that level.
Here are three safe stocks to buy because they make the grade.
Safe Stocks to Buy: IDT Corporation (IDT)
IDT Corporation (NYSE:IDT) is a telecommunications company that operates in both telecom services and payments.
Its Zedge Holdings segment is an online platform for mobile phone users looking to get free apps, games, and customizable mobile tools, such as ringtones, wallpapers and notifications. Zedge has been one of the most popular apps downloaded from both Google Inc (NASDAQ:GOOG) Play and Apple Inc.’s (NASDAQ:AAPL) App Store.
CEO Shmuel Jonas recently addressed the outlook for IDT:
“We are making good progress on our international money transfer business and other important long-term growth initiatives, such as the addition of new features and services to our Boss Revolution app, including instant messaging, which is scheduled for release later this calendar year.”
Through the company’s telecom platform services segment, IDT’s Boss Revolution system offers domestic and international calling and payment services.
IDT trades at an EV/EBITDA ratio of just 2.3 times, and the Z-score is a healthy 4.3. As a bonus, IDT stock has an above-average yield of 3.93%, so investors get paid to wait for favorable developments.
Safe Stocks to Buy: RPX Corporation (RPXC)
RPX Corporation (NASDAQ:RPXC) offers patent risk management services, primarily in the United States and Japan. Basically, the company acquires patents and patent rights, and it helps mitigate and manage patent risk for its client network. It also offers advisory services and what it calls patent intelligence.
Business is pretty good, as sales have grown by 51% annually for the past five years.
RPXC also recently announced the launch of the RPX Open Patent Exchange Network, which is designed to make the patents-transaction process more transparent. Network members, which include Apple and Cisco Systems, Inc. (NASDAQ:CSCO), promise to notify the exchange at least 45 days before transferring patents to nonpracticing entities. These nonpracticing entities, commonly called patent trolls, have historically been the source of many patent-related lawsuits.
The stock is cheap with an EV/EBITDA ratio of just 2.5 times and a solid 2.44 Z-score.
Safe Stocks to Buy: Argan, Inc. (AGX)
Argan, Inc. (NYSE:AGX) is a heavy construction company that builds for the energy, alternative energy and telecommunications industries. It builds biomass, wind and solar plants for the alternative energy markets, which should remain high-growth markets for at least the next decade. AGX works for all levels of government, electric utilities, telecommunications and broadband companies in the mid-Atlantic region.
Business has been good, with 28% five years earnings growth, and it appears to be picking up as earnings grew by 66% this year and doubled on a year-over-year basis last quarter.
The company is posting solid results and its future looks bright, but the stock is still fairly cheap with an EV/EBITDA ratio of just 2.8. The company is in sound financial shape with a Z-score of 3.8.
Argan could easily turn out to be a growth stock disguised a value stock.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.