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Like profits, balance sheets matter

Take a bow, Yahoo. Step up to the podium, Cognizant Technology Solutions. Looking good, Ralph Lauren.

These and 20 other companies are on my roster of Balance Sheet Powerhouses for 2013 — compiled to honor companies with unusually strong balance sheets and to counter monomania about earnings. Many investors care only whether earnings are growing, and whether earnings beat expectations. Those things are important, but far from the whole ballgame. Many investors neglect balance-sheet strength. To make my list, a company must have:

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 A market value of $1 billion or more.

 Cash or near-cash of $300 ­million or more.

 Long-term debt of $200 ­million or less.

 Total debt no more than 10 percent of stockholders’ equity.

 A current ratio (current assets divided by current liabilities) of 1.0 or more.

 Fully diluted earnings of at least 10 cents a share in the latest fiscal year.

I have compiled the list nine times, 2000 through 2006 and 2011 to now. This year, 24 companies made the cut — the shortest list since 2003. Here is the new roster:

 Nine-time winner: Forest ­Laboratories.

 Eight-time winner: Qualcomm Inc.

 Six-time winner: Gentex Corp.

 Five-time winner: Bed Bath & Beyond Inc.

 Four-time winners: American Eagle Outfitters Inc., Dolby Laboratories Inc.

 Three-time winners: Activision Blizzard Inc., Cognizant Technology Solutions Corp., Expeditors­ International of Washington Inc., Micros Systems Inc.

 Two-time winners: Amdocs Ltd., Hittite Microwave Corp., Intuitive Surgical Inc., LSI Corp., MKS Instruments Inc., SEI Investments Co., Skyworks Solutions Inc.

 First-time winners: Align Technology Inc., CommVault Systems Inc., Entegris Inc., Progress Software Corp., Ralph Lauren Corp., ­Ultratech Inc., Yahoo Inc.

Because the Balance Sheet Powerhouses are obviously excellent companies, they are often priced out of the value range I prefer. In other words, they are all good companies, but only some are good stocks to buy. Each year, I recommend Powerhouses as stocks I think can be bought for their capital-appreciation potential.

Last year I selected three: Forest Laboratories, Activision Blizzard, and MKS Instruments. From Feb. 21, 2012, through Feb. 8, 2013, Forest Labs rose 11 percent (including dividends). Activision returned 13.2 percent, and MKS lost 9 percent. All three performed worse than the Standard & Poor’s 500 index, which returned 13.9 percent. The average return for my picks was 5.03 percent.

Long-term, the results are better. In eight years, my recommendations in this series have produced an average one-year return of 21.9 percent, versus 5.9 percent for the S&P 500.

These are paper returns, with no allowance for trading costs or taxes. Results of column recommendations shouldn’t be confused with those for portfolios I run for clients. Past performance doesn’t predict future results. Also, while average returns were good, that was due in large part to a few big winners. Four of my eight sets of recommendations beat the S&P 500, and five of the eight were profitable.

This year, I will again recommend three stocks. One is a repeat – Activision. The video game company is debt-free, and its stock sells for 13 times earnings.

I also like Bed Bath & Beyond. This retailer of home goods could benefit from a pretty good year for consumer spending. This stock sells for 14 times earnings.

Finally, I like Dolby Laboratories Inc., whose audio equipment is used by amateurs and professionals. Shares in this debt-free company go for 14 times earnings.

The other 21 companies on this year’s list sell for 15 to 203 times earnings. They all richly deserve recognition — but you won’t find a cheapskate investor like me paying up for them.

John Dorfman is chairman of Thunderstorm Capital in Boston. His firm or clients may own or trade securities discussed in this column.
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