Due to a 480 percent gain by Anacor Pharmaceuticals Inc. (ANAC), my recommendations from a year ago on five stocks with fat profit margins did very well.
Anacor won a big arbitration case against Valeant Pharmaceuticals, dealing with a medication that treats toe fungus. That is the company’s lead product, but it has several promising ones in clinical trials. After the huge gain in the past year, the stock is now too expensive for me to recommend.
My four other recommendations from a year ago had more down-to-earth results. ProAssurance Corp. (PRA) and Pulte Group Inc. (PHM) returned 12.8 percent and 9.7 percent, respectively. Microsoft Corp. (MSFT) eked out a 0.04 percent return. And I had one big loser: Approach Resources Inc. (AREX), a small energy stock, fell 87.3 percent as oil prices plunged.
In all, my five selections gained 83.2 percent. By comparison, the Standard & Poor’s 500 index was up 1.37 percent.
Bear in mind that the performance of my column picks is hypothetical and does not reflect actual trades, trading costs or taxes. Past performance doesn’t predict the future. And the results of my column selections shouldn’t be confused with actual returns I obtain for clients as a money manager.
Last year’s results were a welcome improvement, since previously I had achieved poor results on my columns on this topic. With the latest results, the average return for five columns rose to 26 percent, compared with 15.5 percent for the Standard & Poor’s 500 Index over the same five 12-month periods. Even so, I beat the S&P 500 only twice in five outings.
I originally got the idea for this series from Louis Navellier, an investment manager and market pundit from Incline Village, Nevada. On the investment conference circuit, Navellier has mentioned that he likes stocks with profit margins that are “fat” and “obscene.”
Logical as that approach may sound, there are risks to it. High profit margins may lure new competitors into an industry. Or they may be the result of temporary and abnormal circumstances. Yet it’s hard to deny that a high profit margin (earnings as a percentage of a company’s revenue) is a sign that the company is doing something right. Either its product is in keen demand, or it is doing a great job of controlling expenses, or both.
Here are my five new recommendations on stocks that boast profit margins of 25 percent or better.
Chemtura Corp. (CHMT), based in Philadelphia, makes specialty chemicals, including lubricants, flame retardants, fluids used in oil drilling and many more. Sales have been flattish the past three years, but profitability has improved to the point that last year the company enjoyed a 39 percent profit margin. I believe the U.S. economy is still strengthening, which should help Chemtura. The low price of oil (a raw material for some chemicals) may help it too.
A leading maker of flat-screen display panels, Corning Inc. has the ticker symbol GLW, giving rise to its Wall Street nickname, Glowworm. The stock sells for only eight times earnings, but I think it deserves a higher valuation, given the company’s 30 percent profit margin. In addition to display screens, Corning makes optical fiber and other glass and ceramic products. Sales have been growing slowly, profits more rapidly.
The largest investment manager in the world, BlackRock Inc. (BLK) manages $4.7 trillion in more than 100 countries. It offers an array of stock and bond mutual funds, exchange-traded funds under the name i-shares, and other investment vehicles. Last year its profit margin was 33 percent. I currently own BlackRock stock for one client. But I consider it a good value and might buy it more broadly.
PacWest Bancorp (PACW), parent to Pacific Western bank, is a Los Angeles-based commercial bank that does business mainly in California but makes loans nationwide. Its profit margin was 32 percent last year. Earnings have been growing rapidly, but the stock can be had for 15 times the past four quarters’ earnings, a reasonable multiple.
Many biotech companies represent hope in a test tube. Gilead Sciences Inc. (GILD) is a more mature business. It already has more than a dozen drugs on the market and a similar number in clinical trials. Among its drugs are ones intended to treat hepatitis C, leukemia and AIDS. I own Gilead shares for almost all of my clients. Its profit margin is 51 percent. The stock sells for 11 times recent earnings and nine times the earnings analysts project for 2016.
John Dorfman is chairman of Dorfman Value Investments in Boston and a syndicated columnist. He can be reached at email@example.com.