Who is John Neff?
John Neff was the legendary manager of Vanguard’s Windsor Fund from 1964 to 1995. During his three-decade tenure, the fund averaged a 13.7% annual return, beating the S&P 500 by an average of over 3 percentage points per year. That track record made him one of the greatest investors of all time. Neff’s approach was, in his own words, “relatively prosaic, dull, [and] conservative.” He focused on beaten-down, unloved stocks with low price-earnings ratios. Neff believed that as long as a company was fundamentally sound, a low P/E meant it had been oversold and was due for a rebound. Neff detailed his low P/E approach in his book John Neff on Investing. Originally published in 1999, it provides a straightforward look at how Neff used a combination of low multiples and fundamental strength to find winning stocks again and again.
The Neff-Based Validea Model
Validea used John Neff on Investing and other public sources to build a quantitative model that encapsulates Neff’s approach. The model looks for stocks with the following characteristics:
- P/E Ratio: The P/E must be 40-60% of the market average to find companies that are out of favor. However, the P/E must be above 5 to avoid weak companies.
- Earnings Growth: EPS growth must be between 7% and 20% on average over the past 3, 4 and 5 years. Very high growth rates often can’t be sustained.
- Future Growth: Analysts’ consensus estimates for long-term and current year EPS growth must both be over 6%.
- Sales Growth: Sales growth over past 3, 4 and 5 years must be either over 7% or at least 70% as high as EPS growth, showing growth is driven by sales, not cost-cutting.
- Total Return/PE: The sum of the EPS growth rate and dividend yield, divided by the P/E, must be at least twice the market or industry average, showing a stock provides a lot of “bang for the buck”. The model also looks for persistent year-over-year increases in quarterly earnings, and gives extra credit for positive free cash flow.
Current Neff-Type Stocks
Here are four stocks that currently earn high marks from Validea’s Neff-based model:
- Dick’s Sporting Goods (DKS): Dick’s is a full-line sporting goods retailer with over 850 stores. It has a P/E of 15.3, 43% below the market average. EPS have grown an average of 34% per year over the past 3-5 years and sales 10% per year. Quarterly EPS have increased each of the past 4 quarters vs. the year-ago periods. Its total return/PE of 2.36 is more than 3x the industry average.
- Nexstar Media Group (NXST): Nexstar owns television stations and websites across the U.S. It has a P/E of 13.3, 51% below market average. EPS have increased 18% and sales 9% per year over the past 3-5 years. Analysts expect 58% long-term growth. Its total return/PE is 1.68, more than double the industry average. Free cash flow is strong.
- Berry Global Group (BERY): Berry makes plastic packaging products. Its P/E of 14.1 is 48% below the market. It has grown EPS 17% and sales 7% per year long term. Analysts expect 51% EPS growth this year and 9% long term. Its total return/PE is over 1.3, more than double the market average. Free cash flow is $6.50 per share.
- Spire Inc (SR): Utility firm Spire’s 15.2 P/E is 44% below market average. Its EPS have grown 16.8% and sales 9% per year over past 3-5 years. Analysts expect 12% EPS growth this year and 6% long term. Its total return/PE is double the market average.
John Neff showed that a focus on low P/E stocks with good fundamentals could outperform the market over the long term. By using a quantitative model based on Neff’s approach, Validea is identifying stocks like DKS, NXST, BERY and SR that share the characteristics that made Neff so successful.
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