Richard Russell’s Latest Miscue

The New Low team has been huge fans of Richard Russell for years. We've learn much about Russell's thinking process as well as his stock market strategy in his work from 1958 to the present. However, his most recent contribution appears to be counter to the whole point of Dow Theory. The following excerpt appears on Financial Sense as well as Dow Theory Letters.

What's the best performing stock of the last few years? Would you believe it -- it's a leading seller of bolts, screws and nuts. (Their products are known as threaded fasteners in the trade.) The name of the hot company is Fastenal.

The stock has been trading for 25 years. The stock has as gone from 13 cents on October 19, 1987 to a recent $50.85. Over the past year Fastenal has gained 60%.

The company stocks thousands of varieties of bolts, nuts, screws and cotter pins in 2,600 stores and serves retail and wholesale customers. For many companies, Fastenal's products are absolutely essential. Whole factories can shut down for lack of one of Fastenal's specially threaded bolts. Fastenal has no serious competition. It would be too difficult to compete with Fastenal's thousands of products for spot delivery. In other words, while Fastenal's products are mundane, many companies can't live without them. If maybe five of a certain bolt is needed, price is absolutely no object. The particular bolt may cost a dollar a piece, but if Fastenal can supply the bolt immediately, the price doesn't mean a thing.

Fastenal had 45 stores in 1987, which was the year its owner decided to take Fastenal public. The company offered 100,000 of the million shares to its employees. Up to date, the price of Fastenal has risen 38,565% and today the company has a market value of $15 billion. It has stores in all 50 states and has also moved into Mexico, Canada, Asia and Europe.

Lesson -- Deal in products that everyone needs. Supply those products in varieties that are beyond the capabilities of any other purveyor. Then offer your products for immediate delivery.

Followers of Dow Theory should know that investment values is the cornerstone of the theory.  This means that even if you don't know anything stock market technicals, buying stocks that are undervalued should be the primary focus.

Unfortunately, it seems that Mr. Russell will revert to the values of Dow Theory when it fits his "mood."  Russell suggests that the market is overvalued based on the dividend yield on the Dow Jones Industrial Average being below 3%.  Why then would he write about Fastenal (FAST) which is at an all-time high and trading at P/E of 43 with a book value of 4.94x?  Additionally, Value Line Investment Survey has estimated that FAST has a fair value at 22x cash flow. Given their 2012 estimate of $1.65 of cash flow per share, we can conservatively say this company is worth $36.

For the sake of reference, we've highlighted Fastenal (FAST) in an April 24, 2010 article titled "Low Yielding Stocks Offer Exceptional Gains".  At the heart of our article was to demonstrate that many stocks with low dividend yields can perform equally as well, if not better, than stocks with high dividend yields given the right conditions (i.e. payout ratio, historical yield range).

Sure this stock could turn out to be the next "Apple" but as an influential Dow Theorist, Russell shouldn't be preaching the merits of a company that is as over-valued as FAST.

Also, we'd like to critique Richard Russell's "lesson." The lesson rings hollow since it suggests investment in "wide moat" companies but doesn't offer up any reasonable alternatives.  This implies that investors acquire shares of FAST at the current price solely based on their "moat" while overlooking the fact that the company is not undervalued.  This is quite alarming since there is a broad range of companies which appears on our latest watch list.

Reference Sources:
What’s the Best Performing Stock of the Last Few Years?
Fastenal Key Statistic as of 3/20/2012
Low Yielding Stocks Offer Exceptional Gains
Dividend Watch List: March 16, 2012

2 responses to “Richard Russell’s Latest Miscue

  1. You have diplomatically pointed out that Russell seems to have lost his way. He is just another example of a guru who proves their fallibility after a impressive run of luck peters out.

    However, I read the excerpt about Fastenal above, and while I agree the current metrics of this company fail to make it attractive as an investment, it doesn’t appear Russell was recommending it. I think it was his lesson of what to look for in a potential stock, which is extremely easy to do in hindsight, but much more difficult to practice in real time.

    Thanks of the excellent blog. I refer to your screens during times of extreme market turbulence.

  2. Greetings Barron,

    Our challenge with Russell’s indication of what to look for in an individual stock is that he never mentions a stock when it is undervalued. Instead, all references to values are done after the fact or it never meets the criteria necessary to compound income.

    As an example, Russell made a clear recommendation of Nuance Communications (NUAN) on Jan. 13, 2012 and BYD Co. (BYDDF.PK) on May 1, 2009. Neither stocks allow for compounding, contradicting his great article ” Rich Man, Poor Man: The power of compounding.” While there is absolutely no possibility of compounding in either stock, Russell never cautioned on selling BYDDF.PK when it was selling at 4 times his original recommendation of $2.81. Now BYDDF.PK is selling at $2.67 after nearly 3 years.

    Dow Theory is ideally supposed to lead you to recognize values in the market regardless of whether we’re in a bull or bear market. Russell has not distinguished himself as having this ability. Our updated “About Us” section highlights our macro and micro perspective that, at times, has allowed us to apply Dow Theory to recognizing values in the market as they happen. This is what Dow Theory has taught us when it is critically analyzed and then applied.

    Thanks for your comments on our work. Your site, Stock Market Advantage, is a must read for anyone wishing to get a pulse of the most prominent commentators on the market.

    Best regards.