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My Deep Value Stock Screen

October 10, 2008 | Comments: 0
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FOSL | JAS | SOL | TRA | UNM

I am a value investor who looks for bargains. And right now, my favorite screen is saying Fossil (FOSL - Snapshot Report), Jo-Ann Stores (JAS - Snapshot Report), ReneSola (SOL - Analyst Report), Terra Industries (TRA - Snapshot Report) and Unum Group (UNM - Analyst Report) are bargains.

What Is A Bargain?

Value investing is commonly defined as buying stocks that are trading at low P/E or price-to-book (P/B) multiples. However, a cheap valuation does not automatically make a stock a bargain. Some stocks deserve to have a low P/E or P/B.

A stock is a bargain when its valuation does not adequately account for the company's prospects. A fundamentally sound company with rising earnings estimates and good growth prospects should not be trading close to book value. Conversely, a company with horrible business prospects deserves a low valuation.

Finding Bargain Stocks

To identify stocks that could be true bargains, I created a stock screening strategy that uses the following criteria:

  • P/E below 18 and below the company's peers
  • P/B below 3 and below the company's peers
  • Intangibles account for less than 35% of shareholder equity
  • Positive earnings estimate revisions within the past 12 weeks
  • No negative earnings estimate revisions within the past 4 weeks
  • A positive EPS surprise for the last reported quarter
  • Zacks #1 Rank or Zacks #2 Rank
  • Positive ROE
  • Projected EPS growth of 10% for this year and next

Followers of Benjamin Graham should immediately recognize the value criteria. I personally like P/B, because a fundamentally sound company should not be trading anywhere near the net value of its underlying assets.

I added the requirement for a proportionately low level of intangibles, because it is difficult to accurately access their true value. A company can inflate its balance sheet by claiming goodwill, but a potential buyer might view the reported valuation of the intangibles with skepticism.

Earnings surprises matter because CFOs may cut a potentially profitable project if it means reducing the severity of a profit disappointment. It may also suggest that the company is struggling with current business conditions.

The rationale for the 2 sets of earnings estimate revisions is to eliminate those companies where analysts have recently become less bullish on a company's prospects. By including revisions for a 12-week period, however, I'm able to cast a wider net.

My preference is for ROE to be above 10%. ROE varies by industry, however, so I would rather just look at it on an individual company basis than screen for a specific number.

Finally, I want to see that analysts expect the company to continue growing. Growth + low valuation is a good formula for higher stock prices.

Deep Value Stocks

Here are 5 stocks currently identified by the screen:

Watch and accessory maker Fossil (FOSL - Snapshot Report) widened its gross margin last quarter, while growing sales 15%. Brokerage analysts think the company can weather the current economic storm and have stuck to their projections for 17% EPS growth next year. FOSL is a Zacks #1 Rank ("strong buy") stock trading at 10.7x earnings and 1.9x book value.

Fabric and craft retailer Jo-Ann Stores (JAS - Snapshot Report) saw second-quarter same-store sales rise 3.3%. Brokerage analysts think the company can maintain its positive momentum into next year, with profits forecast to grow by 16%. The good growth prospects are not priced into the stock, however, with shares trading right at book value. JAS is a Zacks #2 Rank ("buy") stock.

ReneSola (SOL - Analyst Report) manufacturers solar wafers that are sold to other companies for use in the production of solar cells. This Chinese company has been expanding rapidly and is highly profitable. Market conditions, however, have caused the stock to fall below book value. This ultra low valuation masks the fact that brokerage analysts expect ReneSola to generate 80% profit growth next year. SOL is a Zacks #1 Rank stock.

Like many other fertilizer companies, shares of Terra Industries (TRA - Snapshot Report) have been in a free fall during the past few weeks. At the same time, however, brokerage analysts have raised their 2009 projections. Once the stock stabilizes, investors could be looking a bargain with a P/E multiple below 5 and a P/B multiple of 1.9. TRA is a Zacks #1 Rank stock.

Disability insurer Unum Group (UNM - Analyst Report) belongs to small group of financial stocks that analysts are becoming more bullish on. During the past 4 weeks, the 2009 consensus earnings estimate has been revised upwards. Nonetheless, shares trade at just 0.7x book value. UNM is a Zacks #2 Rank stock.

How I Screen

I built this screen for our Research Wizard stock screening program. If you are a Research Wizard subscriber and want the screen, send me an email at crotblut@zacks.com.

A simplified version of this screen can be created in our Custom Screener. It won't be as complex, but a good list of stock ideas can be generated. Investors can use the financial statement and earnings estimate data that is available on Zacks.com to then narrow down the list of stocks.

The big difference between running the screen in Research Wizard and Custom Screener is that Research Wizard will reduce your research time by narrowing down the list of potential candidates.

Charles Rotblut, CFA is the Senior Market Analyst for Zacks.com.