Assessing 'Perfect Stock' Candidates

 | Jan 08, 2014 | 4:00 PM EST
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Today I want to continue searching the market's dark corners for ideas worthy of investment consideration in an extended market. I cannot predict market direction and for all I know, the optimists will be right and the market will shake off the news of the Fed's decision to taper its quantitative easing program and higher interest rates and just continue to march higher.

I certainly hope not this is not the case. However, my crystal ball has never worked well, so I want to be invested in ideas that I can find with the expectation that the upside of my safe and cheap stocks over time will offset being underinvested in stocks.

Today I am running my "perfect stock" screen. It is a modified version of the Walter Schloss screen that has also worked very well over the years for me. As I most always do, I start with stocks that are trading below tangible book value. I then screen further to reduce the list to those companies that own as much as they owe, pay a dividend of some sort, have a current ratio of greater than 2 and are profitable. The resulting lists make up my perfect stock candidates and are worth considering for long-term patient value investors.

As with every other list I have run this year, the list is very short. Just 10 stocks made the grade as perfect stocks -- and only five of them have market caps above $50 million. The real values out there are in the microcap and nanocap sectors. Although it requires more effort to do the proper homework, I am confident the work will pay off for those who are willing to do it.

I have previously mentioned many of these stocks as being safe and cheap selections but they are worth a quick review as we start the year. Richardson Electronics (RELL) is one of my favorite stocks to own right now -- if you are a value type as I am it should already be in your portfolio. The company reports earnings after the market close today and the single analyst following the stock is not expecting much from the company. The stock is very cheap, as it is trading at 90% of tangible book value and has about 80% of its market cap in cash. The company is currently profitable and is expected to be so again in 2014. The dividend yield right now is 2.08%. This is a safe and cheap stock that should prove quite profitable for patient investors.

I also remain a huge fan of Friedman Industries (FRD) even though the company cut its dividend in November. This Texas-based company is the steel business and sells flat, finished sheet and plate to industries such as steel distributors, and customers fabricating steel products, such as storage tanks, steel buildings, farm machinery and equipment. The company also sells tubular steel products to pipe distributors and piling contractors. The stock trades at just 92% of book value, has no long-term debt and a current ratio of above 6. As the economy recovers and steel demand picks up, the stock could see a strong rebound.

I have owned L.S. Starrett (SCX) in the past and don't mind owing it again at the stock's current levels. The company makes basic hand tools, including saws, tape measures and utility knives. It also makes precision tools such as calipers, levels and optical measurement devices. With manufacturing facilities in the U.S., the U.K., Brazil and China, the company has a worldwide presence. The stock is cheap, trading at just 90% of tangible book value and carries very little debt. The debt-to-equity ratio is just 0.17 and the current ratio is 5.70. At today's price, the dividend yield is 2.66%.

As always, the best approach with these stocks is to stay small and move slow. It just makes sense to me to scale into stocks and use the market as an ally rather than face it as an enemy. I may be horrible at predicting market direction, but I have developed an excellent Spidey sense over the years for determining when common sense and caution make sense in the stock market. In my experience, it's any day the markets are open.

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