Seeing STARS

 | May 23, 2012 | 4:30 PM EDT  | Comments
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kelya

The stock market seems determined to create some inventory for us. Now down a little more than 9% from the highs, it may be setting up for at least its annual 10%-15% decline. It also appears to have the firepower for a bigger down move of 20% or more, which comes long every few years. Between the messes in Europe, weaker earnings outlook in the U.S. and momentum stock collapses we have seen the fuel for the fire would seem to be there. It doesn't help that the Facebook (FB) IPO that was supposed to bring back retail investors has instead caused them to lose that last scrap of faith in the stock market. It is time to start paying some serious attention to gathering a list of inventory we are interested in adding to the long-term portfolio.

Since my very first day as a stockbroker, I have used Standard and Poor's (S&P) proprietary STARS (STock Appreciation Ranking System) method. To give you some idea of how long the system has been part of my research routine, the first time I used the service, Michael Milken was still revered and feared on Wall Street and the Berlin Wall was still in place.

This morning, I searched for stocks that had the two highest rankings for potential performance over the next six to 12 months. I then winnowed the list down to just those stocks trading below tangible book value to produce a list of stocks that may rebound faster and further than the overall stock market. There are some intriguing ideas on the list, so I will spend the next couple of days exploring the potential inventory.

One stock that leaps off the page is Kelly Services (KELYA), which I have owned with positive results in the past. As one of the oldest names in the staffing business, when the outlook for jobs creation is bleak, the stock tends to sell off and trade at a nice discount to tangible book value. When the economy shows the slightest sign of firming, the stock tends to bounce and then trade at a nice premium to book value. If a sustained recovery materializes, the stock could trade back up into the low $30s, as it did from 2000-07.

In the depths of the credit crisis, the company lost money for two years but revenues and profits have recovered well since then. Analysts have been overly pessimistic about this stock for some time and the company has posted four consecutive strong positive earnings surprises. In spite of this the shares have been weak, falling by almost half over the past year. Right now, the stock is trading at just 80% of tangible book value and appears to be a strong bargain at this level. The stock trades at less than $0.10 on the dollar of sales and has an EV/EBITDA ratio of just 4.3, so it is cheap on all metrics right now. Plus, Kelly has paid off its long-term debt and has plenty of cash.

Shares of Kelley Services are trading as if job growth is going to disappear over the next year. That is a possibility, but for long-term investors who do not think the world is going to end in December, the stock is safe, cheap and will have enormous upside when the economy does have a sustained recovery.

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