Review & Outlook

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Investing in RULCs: A Promising yet Conservative Strategy

Your portfolio may contain REITs, MLPs, BDCs, TIPS or various other investment acronyms, but do you own any RULCs? Perhaps you’ve never heard the term. That’s probably because I coined it myself, or rather cobbled together the acronym from a phrase used by the legendary investor Benjamin Graham.

RULC stands for “relatively unpopular large company”. These are major, sometimes industry-leading companies with substantial assets and often household names. But they have fallen out of favor with the investment community and sometimes the general public, giving them an attractive valuation. They have all the benefits of successful multinational companies — stability, liquidity, vast resources, access to capital, and often a global footprint — but they trade at a discount because they are somehow out of favor.

Benjamin Graham described these stocks in his classic book the Intelligent Investor:

If we assume that it is the habit of the market to overvalue common stocks which have been showing excellent growth or are glamorous for some other reason, it is logical to expect that it will undervalue–relatively, at least–companies that are out of favor because of unsatisfactory developments of a temporary nature. This may be set down as a fundamental approach that should prove both conservative and promising.

The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. While small companies may also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.

Though RULCs aren’t really a special asset class with tax advantages or unique structure like REITs or MLPs they do tend to behave in certain ways. Their size and visibility in the media and the general public tend to magnify their flaws and push down their valuation in bad times. Likewise these same attributes allow them to more readily bounce back when things improve, as Graham says.

The famous “Dogs of the Dow” investment strategy is an example of a RULC investment. The Dogs are the stocks in the Dow that performed worst in the previous year.  RULCs are promising investments that are hiding in plain site. They are well-known and there is tons of information available on them, but because they are so out of favor they are easy to over look.

What are some examples of RULCs in recent years? Many pharmaceutical companies were very out of favor a few years ago because of the approaching “Patent Cliff” along with massive regulatory uncertainty in the years leading up to the Affordable Care Act (Obamacare). Of course the fears were overblown and the pharmaceutical sector has been one of the best performing industries in recent years. Pfizer (PFE) for instance traded at a P/E in the mid single digits in 2010 . The market was not expecting much growth. Of course over the last five years the stock jumped 127% and handily beat the S&P 500.

Apple (AAPL) became something of a RULC after the death of the Steve Jobs when the stock was cut in half in late 2012 and early 2013. The stock snapped back not long after, though, far exceeding its previous highs.

Sherwin Williams (SHW) was one of the leading publicly traded paint companies that fell out of favor during the 2008-2009 housing crisis. The stock traded as low as 10 times earnings in 2009. But just as the saying goes that it’s darkest just before dawn, Sherwin Williams came roaring back as the housing market recovered. Up 280% over the last five years, the stock now trades at a hefty 30 times trailing earnings.

These are all past RULCs but are there any out of favor now that might rebound in the future? One candidate that we identified recently is Wal-Mart (WMT). Wal-Mart is the largest retailer in the world, famous for its “everyday low price” strategy that undercuts virtually all competitors bringing customers substantial savings. Wal-Mart’s growth has stalled somewhat and the company has fallen out of favor because of accusations of bad labor practices and bribery in its international operations. Still, the company has impressive earnings and continues to invest and improve. At 14.5 times earnings, Wal-Mart is trading at a substantial discount to the market and its industry. If any of the company’s growth initiatives to expand abroad, invest in U.S. stores and expand online commerce work out, the stock has some major upside potential that’s not reflected in the current price.

The risk of course is that a RULC simply stays out of favor and goes into decline. This is always a worry, and indeed there is sometimes a long wait, but because these are stable, well-established, often dividend-paying giants, they also have limited downside. This makes investing in RULCs a strategy that is, as Graham says, both promising and conservative.