This month’s theme relates to how one looks at debt in determining which companies are appropriate for one’s portfolio. What originally started off as a pretty simple task, turned to an effort to make sense of what was going on.
It would seem obvious that companies with low debt should yield greater returns over time than those with high debt. Harry Domash recommends a debt to equity ratio (D/E) less than 0.25, and sometimes 0.1; Peter Lynch wanted less than 0.8; Martin Zweig wants low debt compared to industry peers; and David Dreman wants the D/E to be less than 0.2.
The original strategy for this study was to determine the annualized returns of stocks that had specific debt levels. It was assumed by this writer that there would be a strong negative correlation, where as the debt levels increased, the annualized returns decreased. In fact, as one can see, that did not happen. The best we could determine was that companies which had a D/E less than or equal to 1.0 outperformed companies with a higher D/E. While this result was significant, it was determined that it did not help the individual investor to funnel one’s results to find good solid companies that will yield a return in keeping with a “margin of safety” philosophy.
So how is one to streamline the search? Try adding to the screen that the company’s D/E is equal to or lower than last year’s level. Coupling that with a D/E level less than or equal to one, and it will generate a list of companies that will give one a sense of safety. Add our previous concepts of profitable companies that pay a dividend, and a truly healthy list of companies begin to emerge that will perform well over time. The final chart shows annualized returns of companies that have declining or growing debt levels.
Using the basic screen (from portfolio123.com) will give one a list of companies that have yielded an average of 11.42% since 1999. The ten largest companies are listed here:
|No||Ticker||Name||Last||MktCap||EPS (TTM)||Dividends (TTM)||D/E (Previous Quarter)||D/e (Previous Quarter One Year Ago)||Price|
|1||Exxon Mobil Corp||88.66||390,281.34||7.96||2.34||0.05||0.05||88.66|
|3||Johnson & Johnson||89.68||252,376.38||4.51||2.49||0.14||0.19||89.68|
|4||Wal-Mart Stores Inc||75.83||247,660.78||5.13||1.88||0.61||0.63||75.83|
|5||China Mobile Ltd||56.80||228,346.97||5.21||2.20||0.04||0.04||56.80|
|6||Wells Fargo & Co||42.85||227,197.42||3.69||0.99||0.82||0.91||42.85|
|7||Procter & Gamble Co (The)||79.39||217,713.33||3.87||2.29||0.28||0.33||79.39|
|8||Royal Dutch Shell PLC||65.89||207,421.72||7.52||3.48||0.16||0.16||65.89|
|9||HSBC Holdings PLC||55.14||204,475.00||4.13||2.30||0.97||1.13||55.14|