A Buffett-style financial stock with staying power
Posted
Oct 08 2009, 10:22 AM
by
John Reese
Rating:
As the market has surged over the past seven months, one of the driving forces has been financial stocks.
Since the March 9 low, the S&P 500 is up an impressive 56%, but the Financial Select Sector SPDR is up a staggering 138%. And financials are the second-best performing sector year-to-date and over the past three months, according to Morningstar.
But while the financial rally has been steep and swift, it's been driven mostly by the relenting of apocalyptic fears about the sector -- not fundamentals. My Guru Strategies, which use rigorous fundamental tests to analyze stocks, aren't finding a lot of values in the sector right now. For example, while shares of Citigroup (C) have more than quadrupled since the March 9 low, none of my models think it has strong enough fundamentals to make it a solid play right now.
There are, however, a relatively small number of financials that my models are keying in on. And in the most recent rebalancing of my Top Stocks tracking portfolio over at Wall Street Survivor, my Warren Buffett-based strategy snagged one that looks like a winner.
The stock: World Acceptance Corp. (WRLD), a small Greenville, S.C.-based firm that specializes in small, short-term loans. World Acceptance, whose shares have surged almost 130% since the March low, has close to 1,000 offices in the southern and central U.S., and Mexico. Its loans are generally under $3,000 and have durations of less than 24 months, and much of its business comes from repeat customers.
World Acceptance is probably too small ($420 million market cap) for Buffett's Berkshire Hathaway to buy its shares today. But the company exhibits a number of qualities that Buffett has looked for in investments while building his empire, making it just the kind of firm he might target if he had the chance. (Buffett said at Berkshire's 2008 annual meeting that Berkshire's size limited its investment universe, and that managing a smaller company "would open up thousands of opportunities" to him.)
One of the most important of those qualities: earnings predictability. My Buffett-inspired model (based on the book Buffettology by Buffett's former daughter-in-law, Mary Buffett, who worked closely with Warren) targets firms with long histories of solid, stable earnings growth. Buffett has found that that is a good way to find companies that will have solid future growth, and World Acceptance appears to fit the bill. Over the past decade, it has increased earnings per share every year -- including 2008.
For most companies, the Buffett approach looks at the relation of debt to annual earnings. But because financials, by the nature of their businesses, must carry large amounts of debt, it uses a different metric for them: return on assets. My Buffett-based model requires a ten-year average ROA of at least 1.0%. World Acceptance blows that away, at 10.2%.
Another quality Buffett is known to look for is strong management, and he has measured this by looking at how management uses retained earnings. The model I base on his approach takes the amount a company's EPS have increased over the past decade and divides it by the total amount of EPS it has retained (i.e., not paid out in dividends) over the same period. The result should be at least 12%. When we divide the $2.95 that World Acceptance's EPS have increased over the past ten years by the $18.41 in earnings it has retained over that time, we see that management has proven it can earn a return of 16.0% on the earnings it keeps, easily passing the test.
Finally, Buffett is also known to look for companies with a "durable competitive advantage" over their peers, and one way he has done so is by looking at return on equity. Again, my Buffett approach digs deep into a firm's financial history, looking for a 10-year average ROE of at least 15%. At 19.2%, WRLD makes the grade.
Despite the recent improvements, the financial sector remains on somewhat shaky ground, and investing in financial firms simply because their shares are hot, or still below their previous highs, is a recipe for trouble. But with its niche business, World Acceptance isn't your typical financial. And, given its lengthy track record of growing profits -- even during the recession and market plunge of 2008 -- it's certainly worth a look for those looking to dip their toes into the financial sector.
Full disclosure: I'm long WRLD.
John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".
