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August 2020

SEVEN U.S. CONSUMER DISCRETIONARY WITH SIZEABLE LONG-TERM RETURN ON CAPITAL

What are we looking for?

In the second quarter, fiscal and monetary interventions were massive and to some extent, stronger than the shock from the COVID-19. As a result of these interventions, U.S. consumers’ disposable income is 6% higher than it was in January, leaving them with more money than before the crisis.

The economy appears to be recovering quickly with U.S. retail sales growing at 1.1% year-over-year favoring cyclical stocks. We will look at U.S. large caps operating in the consumer discretionary sector. These are serious candidates where consumers could spend their extra cash.

The screen (click here to access the screen through Stockpointer)

We screened U.S. companies focusing on the following criteria:

  • Market capitalization higher than 15 billion;
  • StockPointer (SP) Performance Score of more than 75 – The score mainly considers risk-adjusted return on capital and free cash flow per share. The score varies between zero and 100;
  • Return on capital (5Y mean) higher than 12% – We look for a firm with a considerable return on capital. Consumer discretionary stocks have profited from the last economic boom so we can set a high return on capital;
  • Positive 3 month change in sales – We want a business whose sales have not been hit too hard by the COVID-19;
  • Positive 1Y dividend growth – We look for a company that didn’t stop to increase its dividend.

    For informational purposes, we have also included recent, stock price, dividend yield, one-year price return, net operating profit (NOP) change over 24 months, return on capital and earnings per share growth (5Y-mean);

More about Inovestor

Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios, and easily communicate investment decisions with clients through client-friendly reports. In addition, Inovestor allows users to create personalized filters, build custom portfolios and carry out in-depth analysis on more than 13,000 companies (Canadian and U.S. stocks and American depositary receipts).

TICKER NAME PRICE ($) MKT CAP ($MIL.) SP PERF. SCORE RTN ON CAPITAL 5Y-MEAN (%) SALES CH. 3M (%) 1Y DIV. GROWTH (%) NOP CH. 24M EPS GROWTH 5Y-MEAN RTN ON CAPITAL (%) DIV. YIELD (%) 1Y PRICE RTN. (%)
HD-N Home Depot, Inc. 271.64 292160 90.0 30.4 1.7 25.4 20.3 15.3 35.5 2.2 29.4
ORLY-Q O’reilly Automotive, Inc. 465.18 34470 77.7 26.7 4.9 0.0 24.5 19.9 29.2 0.0 21.9
AZO-N Autozone, Inc. 1182.22 27620 76.5 26.4 0.0 0.0 7.6 13.0 28.8 0.0 8.6
TSCO-Q Tractor Supply Company 148.1 17120 88.5 18.2 9.7 9.4 43.4 14.9 23.2 1.1 35.8
LOW-N Lowe’s Companies, Inc. 152.78 115350 88.0 16.2 2.7 14.6 23.1 16.2 20.4 1.4 52.1
COST-Q Costco Wholesale Corporation 340.91 150520 82.7 13.1 1.6 12.3 30.1 9.9 14.2 0.8 24.1
DG-N Dollar General Corporation 195.29 49160 84.1 13.0 6.6 10.9 22.6 16.5 14.0 0.7 42.1

What we found

Home improvement retailer Home Depot has an impressive performance score of 90. The 5Y return on capital is also incredible at 30%. In the long run, we expect the company will manage to increase its sales around the GDP growth level while adding small amount of capital. The increase in free cash flow will allow to increase the dividend. The various restrictions related to the pandemic may have pushed consumer to renovate their house during their spare time. The company reports their Q2 on August 18th before market opening.

Auto parts & equipments retailer O’reilly Automotive has a robust return on capital of 26.7%. Its short-term sales grew by 4.9% despite the pandemic during Q2 showing strong execution by management while facing important demand by consumers. Individuals may have used their cars more for vacations as other options were limited. The company generated an impressive annual EPS growth of almost 20% in the last 5-year period. The company doesn’t pay a dividend, but it returned $1.1B to shareholders through buybacks.

Farm supply and home improvement retailer Tractor Supply Co. has a trailing twelve month return on capital of 23.1% which compares positively to its 5Y mean of 18.2%. It increased its sales by 9.7% in the last 3 months and realized a NOP growth of 43.4% over 24 months showing great momentum both in the short and medium-term. The dividend growth is lower than other firms figuring on the list, but the company chose to strengthen its balance sheet by adding $1.1B in cash and cash equivalents compared to the previous Q2. An understandable decision considering the circumstances.

Investors are advised to do further research before investing in any of the companies listed in the accompanying table.

Number Cruncher Extra: Home Depot, O’Reilly Automotive & Tractor Supply Company

In our last Number Cruncher we discussed how Home Depot (HD), O’Reilly Automotive (ORLY) & Tractor Supply Company (TSCO) could be good candidates to take advantage of the economic recovery. Now, we’re going to look at these stocks with our Stockpointer software.

Here is the screener we used to find these incredible companies

Let’s start with Home Depot

 

the company has a high score of 68 in our system. It did not experience significant sales growth, but it did increase the most important metric, the EPS. its performance spread continues to increase, which means that the company is increasing its return on capital while maintaining adequate risk for the return on capital achieved

 

Home Depot has an incredible track record which makes it a high quality stock. It is first in all categories except for the return on equity which can be ignored as the company has negative equity due to the many dividends paid and share buybacks that have been made.

O’reilly Automotive has a similar profile than Home Depot, but with a bigger focus on growth specially in the short-term. It has a solid score of 60 with a higher risk perceived by our software. On the other hand, the beta of 0.92 indicates that the stock should be as much volatile than the market.

 

The growth of O’reilly Automotive is impressive because of its magnitude, but also due to its stability. Sales, operating profit and net income were up every year and stock has been repurchased every year also. There is approximately 25% less share outstanding than in June 2016.


Tractor Supply Company as a strong score of 62 while being identified as a growth, quality and low risk stock. The performance spread is increasing at a rapid pace, specificly 68.3% (relatively to its past performance spread) which is spectacular. Unsurprisingly EPS are up 29.8% year-over-year.

The company has a strong short-term momentum, but we cannot conclude it is the only reason. There is a clear break in the growth of its net operating profit in 2018. In March 2017, the company changed its Chief Financial Officer. It is not known if this decision alone made a difference, but it could be one of the reasons.

If you have any questions about the article, feel free to contact Anthony :
Amenard@Inovestor.com

If you would like to sign up for a free trial and learn how Inovestor can benefit you, contact Olivier:
Olamothe@Inovestor.com

New Stockpointer Beta

The formula we used to calculate the beta (β) for companies has changed. The 5-year quarterly beta (20 observations) have been replaced by a weekly 2-year beta. (104 observations)

Changes were made for the following reasons:

  • 2-year beta is widely used across the industry.
  • 2-year beta includes more observations, therefore reducing estimation errors.
  • 2-year beta reflects fundamental changes of a company more accurately and relevant to today’s price.

This results in a small adjustment to the SP scores. (-/+ 1 or 2 points)

The previous definition of the “5Y beta on quarterly prices” will be replaced to reflect the new formula.

If you have any questions or concerns, feel free to contact Anthony Menard: Amenard@Inovestor.com.

Portfolio Manager’s August Comment for July Results

The S&P/TSX rose by 4.5% in July and the S&P500 increased by 5.6% while the MSCI ACWI ex USA gained 4.1%. At the end of the 12-month period ending July 31th, the S&P/TSX posted a positive return of 1.9%. Over the same 12-month period, the S&P500 surged 12% while the MSCI ACWI ex USA gained 0.7%.

The NQICAT recorded a net gain of 8% in July and a 12-month return of -2.3%.
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The best TSX sectors for the month of July were Materials up 13.1%, followed by Consumer Staples up 6.2%, and Information Technology up 6.1%. The worst performing sectors were Financials up 0.1%, Energy up 1% and Health Care up 1.1%.

 

The best monthly performers in the portfolio were Kirkland Lake Gold up 30.9% and Financial National up 22.8%. At the opposite, the weakest contributors were Toronto-Dominon, which was down 0.9% and Great-West down 0.5%.

 

3 stocks were sold and bought in the strategy in July. For this rebalancing, the model required an exposure reduction of to the Materials sector equivalent to 2 stocks. Stella-Jones (SJ) and CCL Industries Inc. Class B (CCL.B) were sold because of their relatively lower SP scores compared to Kirkland and Winpak.
The model also called for the selling of Gildan (GIL) due to a deterioration of its SP score.

 

The model required an increased exposure to Consumer Staples and Consumer Discretionary. The names that made it into those sectors were Empire Company (EMP.A) and Thomson Reuters Corp. (TRI). Richelieu Hardware Ltd (RCH) was bought as a replacement for Gildan.