According to Dorfman, “From Aug. 23, 2005, through Aug. 16, 2006, the Sane Portfolio returned 13%, including dividends. The S&P 500 was up 8.4% in the period.

“Over the past seven years, the average 12-month gain for the Sane Portfolio has been more than 14%, versus 1.3% for the S&P.

“The Sane Portfolio, which I compile each August, is designed as a middle-of-the-road, slightly conservative collection of a dozen stocks. To be eligible for inclusion, a stock doesn’t have to be outstanding in a single respect; rather, it must be fairly good in most respects.”

In order to be in the Sane Portfolio, a stock must meet all the following criteria:

* Debt-to-equity ratio less than 1
* Earnings growth of 5% or more for the last 5 years
* ROE of 10% or more
* P/E ratio of less than 18
* Stock price that is less than 3 times revenue
* Price-to-book value less than 3
* Market value of more than $1 billion.

Now, let’s take the Sane Portfolio and apply it to small-cap stocks. That means the only thing that will change in the above criteria is market cap. Instead of Dorfman’s condition of a market cap of above $1 billion, we will use a market cap below $1 billion.

I used the stock screener on MSN Money. Here are the results:

Mexican Restaurants, Inc. (CASA:NASDAQ). If you’ve ever eaten at Casa Ole, Monterey’s Tex Mex Cafe, Monterey’s Little Mexico, Tortuga Coastal Cantina, La Señorita or Crazy Jose’s, you know that Mexican Restaurants, Inc. owns all these chains.

The company recently posted a quarterly year-over-year earnings growth of 100%. And with a return on equity of 17.59%, it’s no wonder this stock is up 407% in the last five years.

Nutritional supplement maker Neutraceutical Intl. Corp. (NUTR:NASDAQ) has been popping up on many of my small-cap screens for nearly two years. The company sells its supplements through health stores under the brand names Solaray, KAL, Nature’s Life, Natural Balance and Body Gold.

Neutraceutical isn’t an explosive growth stock. Rather, it has been growing earnings slowly, but steadily and churns out a good amount of cash flow. The company has a price-to-cash flow ratio of 8, which is well below its industry’s 9.90 and the S&P’s price-to-cash flow ratio of 15.30.

Given that real estate is topping out and major real estate companies are all seeing falling profits, I was surprised to see a Hawaiian landholding company on the Sane Portfolio screen. I almost didn’t take the Maui Land and Pineapple Co. (MLP:AMEX) seriously.

But Maui Land and Pineapple might be the best contrarian play for 2006. The company owns a valuable 28,600 acres, making it the second largest landholder in Maui island. MLP operates a resort community and a 6,000-acre pineapple cultivation.

Shares of MLP are significantly undervalued. Compare MLP’s P/E ratio of 13.49 to competitor Fresh Del Monte’s P/E of 1,765 (no, that’s not a typo). The packaged and processed goods industry has a P/E of 21.30. If MLP were to be valued at these levels, its stock price would have to rise to $52.40! (The stock is now at $33.37.)

Realizing its value, Steve Case, former chairman of America Online, bought 47% of MLP in 1999.

Here is a quick comparison of the five-year performance of the above three stocks and the S&P 500:

Going by past performance alone, you can see that the three stocks from our Sane Portfolio screen have beaten the S&P. And given their fundamentals, they are poised to the beat the S&P for the next five years, just like John Dorfman’s original Sane Portfolio.

And finally, here are some other winning stocks that showed up on the Sane Portfolio screen:

1. Air T, Inc. (AIRT:NASDAQ). Provides overnight air cargo services for FedEx.
2. Educational Development Corp. (EDUC:NASDAQ). Sole publisher in the U.S. for U.K.’s Usborne childrens books.
3. Jinpan Intl. (JST:AMEX). This Chinese company’s cast resin transformers allow high-voltage transmissions of electricity to be distributed to various locations in lower, more usable voltages.
4. Intervest Bancshares Corp. (IBCA:NASDAQ). Owns Intervest National Bank and Intervest Mortgage Corp.

If you invest in stocks based on the results of a stock screen, like the Sane Portfolio screen, you need to know when to sell. Remember that the best indicator of when to sell a stock is when it no longer satisfies one or more of the criteria that were used to screen the stock.

Regards,

Sala Kannan
August 25, 2006

Do You Have a Sane Portfolio? was originally featured in the Penny Sleuth.