What are we looking for?
At this time of year, we like to think of the less fortunate – in this case, U.S.-traded stocks that are languishing in the bargain bin, but have decent fundamentals.
Joseph Piotroski, a professor at Stanford University, has discovered that applying a battery of accounting tests to a portfolio of value stocks can improve returns by eliminating ones that are financially too weak to recover and spotlighting ones with improving fundamentals.
On Wednesday, we asked our friends at Validea.com for help in finding Canadian stocks that score high by Prof. Piotroski’s standards. (The Globe and Mail has a distribution agreement with Validea.ca, a premium Canadian stock screen service.) Now Validea will turn its attention to the U.S. market.
In keeping with Prof. Piotroski’s strategy, Validea’s first step was to select stocks trading in the top 20 per cent of the market based on their book-value-to-market ratio. These are usually stocks trading in deep value territory.
To avoid the risks inherent in small stocks, Validea looked only at companies with at least $500-million (U.S.) in market capitalization. It assessed each stock on the Piotroski scorecard, giving it a “pass” or “fail” on each of nine criteria:
-Return on assets: Pass if return on assets (ROA) is positive.
-Change in return on assets: Pass if this year’s ROA exceeds prior year’s.
-Cash flow from operations: Pass if the most recent year’s cash flow was positive.
-Cash compared to net income: Pass if cash from operations is greater than net income.
-Change in long-term debt vs. assets: Pass if the ratio of long-term debt to assets has decreased from prior year or stayed the same.
-Change in current ratio: Pass if the current ratio has increased from prior year.
-Change in shares outstanding: Pass if the number of shares outstanding is no larger than year-ago figure.
-Change in gross margins: Pass if gross margin has increased over prior year.
-Change in asset turnover: Pass if asset turnover for the most recent year is greater than asset turnover for the previous year.
What we found
A list heavy with non-U.S. companies – a reflection of the reverses suffered by many foreign markets this year. While there’s no guarantee these stocks will rebound, their fundamentals are better than their lowly stock prices would suggest.
If history repeats itself, at least some of the stocks listed here will do well because they’re cheap in comparison to book value while possessing multiple indicators of financial strength.