It’s time for a visit with an old friend the Sane Portfolio. I designed the Sane Portfolio in August 1999 for “slightly conservative investors.” The original 12 stocks have produced a two-year return of about 34 percent, compared to a loss of about 12 percent for the Standard & Poor’s 500 Index. (Figures are for Aug. 27, 1999, through Aug. 17, 2001.)
The founding members, chosen using seven criteria, were Clayton Homes Inc., Cordant Technologies Inc., Crane Co., Diebold Inc., First American Financial Corp., Hillenbrand Industries Inc., IBP Inc., Johns-Manville Corp., Litton Industries Inc., Mercury General Corp., Neiman-Marcus Group Inc. and Trinity Industries Inc.
In August 2000, the portfolio went in for a tune-up. Cordant had been taken over by Aluminum Co. of America, and First American, Litton and Trinity no longer met all the requirements. So they were dropped and four new companies added: Allstate Corp., H & R; Block Inc., Northrop Grumman Corp. and Outback Steakhouse Inc.
Sane Portfolio II posted a 37 percent return from Aug. 24, 2000, through Aug. 21, 2001, compared with a 22 percent loss for the S & P; 500.
It’s gratifying that the portfolio did so well, although it bears repeating that it is not designed for high performance. It’s intended as a sensible, middle-of-the-road, solid group of stocks that are likely to provide decent performance under most market conditions.
New group
Now, it’s time to launch Sane Portfolio III. To be considered, a stock must have: market value of $1 billion or more, earnings growth averaging at least 5 percent a year in the past five years, return on stockholders’ equity in the latest fiscal year of 10 percent or more, a price-to-earnings ratio (stock price divided by the past four quarters’ earnings) of 18 or less. a price-to-book ratio (stock price divided by corporate net worth per share) of 3 or less, a price-to-sales ratio (stock price divided by per-share revenue) of 3 or less and debt less than stockholders’ equity.
No single criterion is especially difficult. Put them together, though, and only 89 stocks are currently eligible.
Of the 12 stocks in Sane Portfolio II, five will return as part of Sane Portfolio III. They are Allstate, Crane, Neiman-Marcus, Northrop Grumman and Outback Steakhouse.
But seven stocks must drop out. Johns-Manville Corp. was taken over by Berkshire Hathaway Inc. Diebold’s p/e ratio has risen to just above 18. Hillenbrand’s has risen to 21, Mercury General’s to 22 and H & R; Block’s to 25. IBP is still cheap enough but profitability has fallen below the standard. The same is true of Clayton Homes.
So, as we launch the third annual Sane Portfolio, there’s room for seven new stocks.
Since I think the outlook for energy is strong, I will start by adding both Apache Corp. and Anadarko Petroleum to the list. Both are independent exploration and production companies that drill for natural gas as well as oil. Apache sells for seven times recent earnings, Anadarko for eight.
Men’s Wearhouse Inc., a clothing retailer that I recommended in the column on July 31, comes next. It sells for 13 times earnings.
Then we’ll throw in Tellabs Inc., the largest maker of equipment used to manage traffic on telephone networks. It’s struggling, having posted a second-quarter loss on a 35 percent drop in sales. The stock has fallen from a high of $77.19 in late 1999 to a recent price of $13.55.
In the same vein, we will add Solectron Corp., a maker of microelectronic assemblies used in computers and communications equipment. The stock is down 59 percent this year as both the computer industry and the telecommunications industry have slumped. At 14 times recent earnings, I think it is a bargain.
FedEx Corp., formerly known as Federal Express, continues to show steady progress in sales. Progress in earnings has been less steady (the company earned $584 million in fiscal 2001, down from $688 million the year before), but the company hasn’t had a loss since 1987.
Straw hats
The final spot in Sane Portfolio III will go to Royal Caribbean Cruises Ltd. It may seem ill-timed to buy stock in a cruise line operator when it looks as if the U.S. may be going into a recession. But Royal Caribbean’s stock has fallen to $23.31 from a high of more than $56 in late 1999. I think the stock has already anticipated a recession.
John Dorfman is a columnist with Bloomberg News.
