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Finding Stocks in the Value Bin
Considering the beating that
many otherwise good stocks have endured over the past few months,
this might be a good time to consider building a portfolio of value-priced
stocks.
While, most investors look for fast growing
companies such as Google or Apple, value investors seek out stocks with strong
fundamental outlooks, but trading at bargain prices. This usually happens when
a former high-flier reports sales or earnings numbers that were below market
expectations. When that happens, growth investors give up on the stock.
Unfortunately, picking qualified value candidates
isn’t as simple as buying beaten-down stocks. In fact, most cheap stocks will
get even cheaper.
Screen for Value Candidates
You can use the free and easy to
use screening program provided by FINVIZ.com to find worthwhile value stock
candidates. If you’re not familiar with the term, screening is a process for
scanning the market for stocks meeting your specific requirements.
Here are my ideas for using FINVIZ.com to find
value candidates with reasonable turnaround prospects. Start from the FINVIZ
homepage (finviz.com) by
selecting Screener.
You use a screener by specifying selection
criteria, which FINVIZ calls “filters.” On the Filters bar, select “All” so
that you can see all of the available filters at the same time. I’ll include
the actual screening term I used in parenthesis after each description. The
first step is to isolate potential value candidates.
Value Universe
Most investors rely on valuation ratios such as price/earnings to pinpoint
value candidates. But I find it works best to search directly for the one
thing that all value stocks have in common; a beaten down share price.
I arbitrarily defined “beaten down” as meaning a
minimum 50% price drop over the past 12-months (Performance:
Year minus 50%). Cut that requirement down to a minimum 30% drop if you
want to see more stocks.
Since most stocks that have taken such a hit will
continue to fall, isolate the most promising candidates by focusing on stocks
whose prices have leveled off and have already moved up a least 10% from their
lows (52-Week High/Low:
10% or more above low).
In my experience, stocks trading at exceptionally
low prices are riskier than stocks trading at higher prices. Thus, I require a
minimum $10 trading price (Price:
Over $10). Increase that minimum to $15 if you want to cut your risk,
or lower it to $5 if you want to see more stocks.
Strong Financials
Among value-priced stocks, those with the strongest financials are the most
likely to recover. The next two requirements pinpoint those stocks, starting
with low-debt.
The long-term debt/equity ratio compares
long-term debt to shareholders equity (book value). The higher the ratio; the
higher the debt. Generally, ratios above 1.0 signal high-debt, and ratios
below 0.5 denote relatively low-debt. However, in terms of debt, lower is
always better.
I set the maximum long-term D/E ratio at a very
stringent 0.2 (LT Debt/Equity:
Under 0.2). Move the limit up to 0.3 if you want to see more stocks or
down to 0.1 if you want to cut your risk.
Profitability is another important financial
strength measure. Return on equity, which compares net income to shareholders
equity is the most widely used profitability gauge. Any positive ROE signals a
profitable firm, but the higher the better. Growth investors typically require
a minimum 15% ROE, but since they’ve recently stumbled, most value candidates
wouldn’t pass that test. I set my minimum ROE at 5%
(Return on Equity:
Over +5%).
Got Growth?
Identifying profitable, low-debt stocks with beaten down share prices is just
a start. Within that group, we must pick the firms most likely to resume
growing earnings after they recover from their current problems. We can use
analysts’ consensus long-term earnings growth forecasts to do that.
How much growth is enough? Usually, 15% or higher
expected long-term annual earnings growth gets the market’s attention, and
that’s what I required (EPS Growth Next
five years: Over 15%). Cut that
requirement to 10% if you want to see more stocks.
Only four stocks passed these tests.
* Country Style Cooking Restaurant Chain (CCSC):
operates quick service restaurants in China.
* Capella Education (CPLA): provides online
post-secondary services through its Capella University unit.
* Dolby Laboratories (DLB): produces sound
equipment for homes and movie theaters, and licenses its technologies to other
sound equipment makers.
* Pacific Capital Bancorp (PCBC): operates banks
in Santa Barbara, San Luis Obispo, and San Benito counties in California.
I ran the screen on October
11, 2011. Click
here to see which stocks the screen is turning up today.
To be a successful value investor, you must be a
contrarian by nature. All of these stocks are out-of-favor with most investors
and stock analysts. That’s why they’re trading far below year-ago highs.
Consider the stocks listed by this screen, or any
screen for that matter, as research candidates, not a buy list. The more you
know about your stocks, the better your results.
10/23/11 |
