Tuesday, May 19, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (May 19, 1998) -- Let me begin today's column with a disclaimer that the opinions here are speculations only. The screen I'm discussing has neither been back-tested nor developed beyond today's discussion. Treat this simply as me thinking aloud and treat that for what it's worth. (Be nice!)

Ah, that's out of the way.

One of the things Warren Buffett likes to see companies do is earn a high return on their own capital. Buffett's not really in favor of cash dividends if the company can invest the earnings better, partly because dividends are an inefficient distribution to shareholders in terms of taxation.

So Buffett's big on companies with high retained earnings if the companies can reinvest the retained earnings profitably. As an experiment, I screened the Value Line database for stocks with a high percentage of retained earnings (better than 25%) and found only 105 companies that met this criterion. This measure of high return on capital is defined in the Value Line universe as "net profit less dividends divided by common equity including tangible assets, expressed as a percentage." It's also called the Plowback Ratio because the company is "plowing" its profits back into the business.

Many of the companies in the group, as you might expect, are somewhat small and speculative. But not all of them. I added a second screen requiring the company have at least a $15 billion market capitalization to focus on the blue chips in the group, which left with me a list of twenty stocks. It's not a bad list of companies to start with. I'll list them here, ranked by their last six months' returns:

Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>
Lucent Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %>
Gap (The) Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %>
Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>
Schering-Plough <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGP)") else Response.Write("(NYSE: SGP)") end if %>
Coca-Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %>
Sun Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SUNW)") else Response.Write("(NYSE: SUNW)") end if %>
Microsoft Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MSFT)") else Response.Write("(NYSE: MSFT)") end if %>
Caterpillar Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %>
Computer Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CA)") else Response.Write("(NYSE: CA)") end if %>
Int'l Business Mach. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>
Amgen <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMGN)") else Response.Write("(Nasdaq: AMGN)") end if %>
Safeway Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWY)") else Response.Write("(NYSE: SWY)") end if %>
Abbott Labs. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABT)") else Response.Write("(NYSE: ABT)") end if %>
Intel Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>
Bestfoods <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BFO)") else Response.Write("(NYSE: BFO)") end if %>
Medtronic Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MDT)") else Response.Write("(NYSE: MDT)") end if %>
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %>
Kellogg <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: K)") else Response.Write("(NYSE: K)") end if %>
Oracle Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>

As a group, the twenty stocks are averaging 25.3% in returns for 1998 (through May 13). Over the past twelve months, they've recorded a fairly astounding 65.1% average gain. And over the last five years, they've averaged 45.3% a year.

Now, whether this is a useful screen for choosing successful stocks in the future (as opposed to looking in reverse as I've done today) remains to be tested and watched in real time. But the theory certainly makes sense. Companies that efficiently reinvest their profits to generate compounded growth are, in effect, managing their portfolios very much as we'd manage them for ourselves. Keep an eye on retained earnings and how efficiently they're reinvested; Buffett didn't build Berkshire-Hathaway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BRK.A)") else Response.Write("(NYSE: BRK.A)") end if %> on luck. Fool on!

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]