WHAT ARE WE LOOKING FOR?
When stock prices fall to historic lows - as they have become in the current bear market - there's a tendency to talk about the market being a "bargain." But in good times as well as bad, not all cheap stocks are bargains.
Investors need to distinguish between stocks that are truly undervalued, and those that are cheap for good reason - their low prices reflect underlying problems.
Today, we look at the screen CPMS Computerized Portfolio Management Services has developed to separate the undiscovered bargains from the unexploded bombs.
CPMS BARGAIN HUNTERS SCREEN
CPMS - a 25-year-old Canadian equity research firm that was recently acquired by fund analysis giant Morningstar Research Inc. - has come up with a screen that focuses on stocks that are inexpensive, yet unencumbered by balance sheet problems that can justify investor antipathy. (Those balance sheet issues are particularly germane given the current tight credit environment.)
Using the screen, CPMS came up with its Bargain Hunters list - for which it has both a Canadian and a U.S. version. Today we present the Canadian list.
CPMS limits the screen to stocks with a market float of at least $200-million. The screen weeds out the contenders from the pretenders using these criteria:
- Price-to-book-value - a stock must have a P/B lower than the median of the 650 Canadian stocks tracked by CPMS.
- Price-to-tangible-book - must be below the median P/B excluding goodwill and intangibles.
- Price-to-cash-flow - must be below the median P/CF for the trailing four quarters.
- Working capital ratio - must exceed 1, i.e. current assets exceeding current liabilities.
- Total-debt-to-equity - must be below 0.5, i.e. equity must be more than double total debt.
To qualify for the Bargain Hunters list, a stock must pass all five of these criteria. (The accompanying table lists the stocks in order of lowest P/B, though CPMS doesn't give any greater weighting to any of the factors.)
WHAT DID WE FIND?
Only 22 Canadian stocks currently pass the Bargain Hunters screen, and that list is top heavy with resource stocks - roughly two-thirds of the portfolio is made up of energy and materials names. While those are two of the biggest sectors on the Toronto Stock Exchange, it's not surprising that the TSX's single biggest sector - financials - is deeply underrepresented on this list (just one stock, Canaccord Capital Inc.), reflecting the balance sheet concerns that continue to dog the sector.
Most of the bargains unearthed by the screen are relatively modest-sized companies. Magna International Inc. is the only stock on the blue-chip S&P/TSX 60 index to crack the list.