In One Up on Wall Street, super investor Peter Lynch detailed a few of the techniques he used to find winning stocks. His goal was to find “10-baggers” — stocks he believed could be eventually sold for at least 10 times the amount he paid for them.
One of the stock-picking techniques he described was a strategy to find undervalued stocks with above-average earnings growth, strong financials and low institutional ownership. The specific criteria he defined were:
— Value is measured with the price-to-earnings (P/E) ratio. Investors should buy stocks with P/E ratios that are below the industry average and also below the stock’s own five-year average P/E ratio.
— Growth is measured by the change in earnings per share (EPS). Look for companies whose EPS has increased faster than average over the past five years.
— Financial strength is defined with the balance sheet. In Lynch’s opinion, the ratio of liabilities to assets needs to be less than the industry average for a stock to be a buy.
— Institutional ownership should be lower than average. This should allow for price gains when institutions discover the stock and crowd into it.
Lynch’s record shows that he was able to uncover at least a few 10-baggers. From 1977 until his retirement in 1990, Lynch delivered average annual gains of 29.2% to investors in his Fidelity Magellan Fund.
I used Lynch’s screen to look for income stocks. In the current market, only two stocks passed the screen.
Over the past seven years, sales have grown an average of 12.6% a year while annual EPS growth has averaged 28.2%. No analysts follow RF Industries, Ltd. (NASDAQ:RFIL), and about 16% of the company’s shares are held by institutions.
RF Industries, Ltd. (NASDAQ:RFIL) has a P/E ratio of 10.2 based on earnings over the past 12 months. The company is debt free and has strong cash flow, which should allow it to continue paying a dividend of $0.28 a year or more. RF Industries, Ltd. (NASDAQ:RFIL) currently offers a yield of 4.8%.
RF Industries, Ltd. (NASDAQ:RFIL) is near a support level. To manage risk, a stop-loss near the recent gap could be used. With a close below $5, RF Industries, Ltd. (NASDAQ:RFIL) would be a sell.
Recommended Trade Setup:
— Buy RFIL up to $6
— Set stop-loss at $5
— Set initial price target at $7.35 for a potential 23% gain in 6-12 months
Longer term, even bigger gains are possible.
Sociedad Quimica y Minera (ADR) (NYSE:SQM) sold off sharply in the last two weeks after one of the two cartels controlling the potash market collapsed. The world’s largest potash producer announced that it would lower its prices by up to 25% this year to increase market share.