Two qualities of outstanding companies are high profitability and low debt. Let's look at a handful of companies that can boast both.
Among the largest 2,000 U.S. companies, about 27% have high profitability, as gauged by a return on stockholders' equity of 20% or more. About 15% of companies have low debt, which I define as debt no more than 10% of stockholders' equity.
Putting those two qualities together is much harder. Fewer than 3% of companies can claim both badges of honor.
Here are five of them that I believe deserve consideration in many people's portfolios.
Graco
Based in Minneapolis, Minnesota, Graco Inc. (GGG, Financial) makes fluid-handling systems and products. Russell Gray, then a parking lot attendant, founded the company in 1926, initially producing grease guns and paint pumps. Gray Company became Graco in 1969, and went public the same year.
Today the company makes sprayers, devices to paint lines on roads, foam and polyurethane equipment, lubrication systems, sealants and all kind of pumps. Its return on equity the past four quarters was 23%, and debt is only 2% of equity.
A.O. Smith
You may have an A.O. Smith Corp. (AOS, Financial) boiler or water heater in your basement, heating your house or providing you with hot water for showers. You may not give the company much thought. But it's quite a successful company, with a 31% return on equity and debt only 8% of equity.
The Milwaukee, Wisconsin company has been profitable in each of the past 30 years. As best I can tell, it hasn't had a loss year since the Great Depression in the 1930s. Over the past decade it has increased its profits by an average of 12% a year.
Mueller Industries
For the third year in a row, I recommend Mueller Industries Inc. (MLI, Financial). It returned 62% and 38% in the first two outings. For the coming year, I anticipate a more modest, but still good, return.
Lately Mueller has posted a 25 return on equity while holding debt down to 1% of equity. Based in Collierville, Tennessee, the company makes metal and plastic fittings such as refrigerator coils. It has reported a profit in each of the past 30 years.
Normally you have to pay up for a stock with this sort of record. But Mueller is pretty cheap, selling for 11 times earnings.
Warrior Met Coal
Warrior Met Coal Inc. (HCC, Financial) has found a nice niche, mining hard coking coal (used in producing steel) in Alabama and exporting it to Latin America. Its return on equity lately has been running at 29% and has exceeded 20% in five of the past seven years.
The company was founded in 2015 and has its headquarters in Brookwood, Alabama. It took over the assets and mines of Walter Energy Inc., which went bankrupt that year. Debt now is only 9% of equity. Coal is not a trendy industry, but you're not paying as if it were. The stock trades at only eight times earnings.
Axcelis Technologies
Based in Beverly, Massachusetts, Axcelis Technologies Inc. (ACLS, Financial) makes ion implantation equipment and other equipment used in making semiconductor chips. The vast ecosystem that makes up the semiconductor industry is prospering because of increasing use of artificial intelligence.
Axcelis has a 31% return on equity of late, and carries debt equal to only 5% of equity. The company mostly posted losses until 2015, but has increased its earnings at better than a 50% annual clip the past five years.
The record
From 2000 to the present, I've written 19 columns on companies with high profit and low debt. (This is number 20.) The average 12-month return on my selections in this series is 11.30%, which narrowly beats the 10.50% average return on the Standard & Poor's 500 Total Return Index over the same periods.
Thirteen of the 19 columns have shown a profit, and 10 of them have beaten the benchmark.
Bear in mind that my column results are hypothetical and shouldn't be confused with results I obtain for clients. Also, past performance doesn't predict the future.
A year ago, I highlighted five stocks in this paradigm. Mueller Industries did best, up 38%. Cal-Maine Foods (CALM, Financial) also did well, returning 26% including dividends. Diodes Inc. (DIOD, Financial) was a loser, dropping 23%. Moderna Inc. (MRNA, Financial) returned 17%, and Civitas Resources Inc. (CIVI, Financial) was up 4%.
Altogether, my 2023 picks returned 12.6%, trailing the S&P 500 Total Return Index at 23.0%.
John Dorfman is chairman of Dorfman Value Investments LLC in Boston, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].
