Stock Selection Criteria

Earnings Power Play

We require Earnings Yield (E/P) in excess of the 20-year AA corporate bond rate.
- Modified “Fed Model. We use the “AA”-rated corporate bond rate in place of the risk-free rate.
- Graham and Dodd used similar criteria and believed that when a stock’s earnings yield > low risk, long-term corporate bond rates, the stock reflected current realities rather than future growth projections.
High Risk-Adjusted Returns have been achieved by buying low P/E stocks, as documented by numerous academic studies.

Consistently high and sustainable return-on-equity in excess of 15% is often the result of a business with wide moats and a defensible niche.
A declining return-on-equity often predicts an earnings decline and thus poor stock performance.

Low debt-to-capital relative to industry peers.
If interest rates cannot consistently be predicted, it’s best to have a clean balance sheet.
Low leverage ratios enable companies to weather the storm.

Positive free cash flow gives management the flexibility to pay and/or raise dividends, buy-back shares, reduce debt, make strategic acquisitions and fund organic growth.
With free cash flow, management can accomplish all of these “value-added” tasks. without tapping the credit markets, a competitive advantage during periods of capital markets stress.

Management should utilize conservative accounting and have incentives that align with shareholders.

Management must be able to articulate a business plan to grow earnings and revenues faster than inflation on a secular basis.

Sells at a minimum 40% discount to conservatively valued tangible assets.
Company should meet criteria for Earnings Power Play in the future under reasonable macro-economic conditions.

Trade at 150% of the price-to-earnings ratio that would qualify the stock for purchase as an earnings power play
Trade at 85% of our estimate of private market value