February Idea of the Month: Clean, Hot Water

Screening for momentum stocks with cheap valuations yields an interesting industrial idea with steady earnings and a kicker

By stock, February 17, 2012

I’ve been browsing around using stock screens for a few weeks now, thinking about “cheap growth” — the strategy of buying stocks that are showing above average growth but that aren’t being given a premium price based on that growth rate. There’s no pure science to determining what “cheap” means, but I often find myself returning to the idea of “growth at a reasonable price.” Being a value investor, and looking for drop-dead bargains, is always enticing … but if a company isn’t growing, there’s no particular reason for it to ever graduate beyond “cheap.” If you can catch a company with a great growth trajectory, even if you catch it after good gains, and it’s not expensive yet, the long-term returns can be remarkable.

So I decided, in tinkering with this screening, to add a few things — I wanted small companies that might be under-followed, so I looked only at market capitalization below five billion dollars (and above $500 million — not too small). I wanted good growth that’s also cheap growth, so I set the PEG ratio (that’s price/earnings/growth) to be below 0.8, firmly in “cheap” territory. I want there to be real financial management and a plan to reward shareholders, too, so I set a criteria that it had to pay a dividend and it had to have raised the dividend at least once in the last couple years.

And finally, I wanted the company to be already appreciated by the market, because I don’t feel like being that patient, so I stipulated that the shares have to be within 5% of the 52-week high (that also helps to make sure you’re getting a “growth” stock, not a beaten-down stock where analysts are projecting a turnaround).

That gave an interesting list of companies, which is all a screen can really do — you certainly don’t want to pick a stock based just on those metrics. But one stock stood out from the list with a compelling story, an almost annuity-like revenue stream from a core business, active, acquisitive management, and a couple key potential “kickers” that could drive the stock higher.

So I looked into it a bit more, and I liked what I saw … that’s our “Idea of the Month” for this month: The water heater and filtration manufacturer A. O. Smith (AOS)

A.O. Smith is a company that has gone through ...

Sign Up for a Premium Membership

To view the rest of this article (and to have full access to the rest of our articles), sign up.
Already a member, log in.

Become a member