Identifying the Rare Firms With Big Profits, Low Prices and a History Of Flying Higher+

Flying Fortress Stocks: Making Money with Margin of Safety Investing

The legendary B-17, the third most produced bomber of all time, earned its name “The Flying Fortress” due to the plane’s ability to withstand severe damage and still find its way home. The plane’s potent defensive capabilities made it a top choice for dangerous daylight bombing missions. Equally important, however was its ability to soar to high altitudes. [1]

As warnings of rank speculation by legendary investors are ignored, our team has decided to keep things simple. Last week we published a Quick Take highlighting that the market cap of firms trading at less than 10x earnings had hit the lowest level in 40 years of stock market history.

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This piece seeks to provide a more potent screen with historical context to help investors looking for a bit of deep value in their portfolios. To make the cut, the firms need to have a market cap of $1bn or greater, have a 10% free cash flow yield, be investment grade, and growing revenues at 5% or more.

Impossible? Almost. As Figure 1 below shows, there are not many firms meeting these stringent criteria. There are plenty of folks on social media encouraging you to embrace 10x price to sales multiples. We’ll stick to our knitting, keep it simple, and try and turn over some compelling stocks shunned or ignored by investors.

Summary:

  • Historically, investing in firms meeting these strict criteria generated outsized returns for investors
  • The performance of these firms generates high absolute returns
  • These firms also provided potent downside protection in years when the indexes suffered losses

Due to their potent offensive and defensive characteristics, we dubbed them “Flying Fortresses.”

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Flying Fortress Stocks: Playing Offense & Absolute Returns

As we have documented extensively, on nearly every metric we are aware of the market is expensive.  On the most reliable metric we use, indexes are beyond the levels seen at the peak of the dot.com bubble.

Fig. 2 below shows the absolute batting averages for our Flying Fortress Stocks (FFS), the S&P 500, and the R2500.  Over the last 40 years you can see that:

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  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.