My Deep Value Stock Screen

I am a value investor who looks for bargains. And right now, my favorite screen is saying Deckers Outdoor Corporation (DECK - Analyst Report), Matrix Service Company (MATX), Richardson Electronics (RELL - Snapshot Report) and Zhongpin (HOGS) 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 plus low valuation is a good formula for higher stock prices.

Deep Value Stocks

Here are 4 stocks currently identified by the screen:

The weakening economy is not hurting Deckers Outdoor Corporation (DECK - Analyst Report). Rather, sales of the company's Ugg boots continue to be strong, despite their higher price point. As a result, brokerage analysts think the company can grow earnings by more than 16% next year. The optimism is no longer factored into the stock's price, however, as is evidenced by the P/B multiple of 2.2. DECK is a Zacks #1 Rank ("strong buy") stock.

Matrix Service Company (MATX) is an energy infrastructure company. MATX provides construction and repair services to the oil, petrochemical and pipeline industries. Though worries about the energy sector have this stock trading at about book value, fiscal first-quarter revenues set new records and the per share profit of 36 cents bested expectations by 6 cents. MATX is a Zacks #2 Rank ("buy") stock.

With average volume of about 50,000 shares per day, Richardson Electronics (RELL - Snapshot Report) might not be suitable for every investor, but its valuation of just 0.4x book value makes it really cheap. The company provides components to the wireless industry, as well as producing other electronic components. Fiscal first-quarter earnings of 20 cents per share were 15 cents above expectations and the full-year consensus earnings estimate has been revised higher. RELL is a Zacks #1 Rank stock.

Zhongpin's (HOGS) valuation of 1.2x book value and 7.7x earnings hides the fact that this company recently reported record revenues and earnings. HOGS is a Chinese meat and food processor that is benefiting from a growing economy and increased demand for pork. The company reiterated its 2008 profit guidance, and brokerage analysts have raised their 2009 earnings estimates. HOGS is a Zacks #1 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.