Safe, Cheap and on Fire

 | Jun 10, 2014 | 3:00 PM EDT
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I lean toward being a pure value investor in the mode of Walter Schloss, and I expect that most of my stocks will go down before they reverse course. Still, a lot of evidence suggests that combining value with price momentum is an effective strategy.

Many studies have shown, in other words, that buying value stocks that have started to perk up is a solid approach to beating the market. In theory, when you combine these two approaches you get stocks that are still cheap but which have improved enough to attract the attention of the big money, and are in the first leg of a full recovery in value. I suspect I will always be a scale buyer of falling knives -- but, for those who want to smooth the volatility and still catch much of the value premium, consider using a momentum filter with safe and cheap stocks.

I sat down this morning and ran a screen of my own to determine which undervalued stocks have recently been on the move and which, therefore, may be ripe for further moves up towards fair value. In doing this, I filtered for stocks that were priced below book value and trading in the bottom half of their three-year range. I then sorted them by three-month price gains in order to see which undervalued companies had begun a march higher. The screen produced an interesting list: In addition to providing a few stock ideas, it has shed light on some market and sector trends.

Namely, in big-picture terms this list reveals that one formerly struggling sector is coming back in favor in a big way among investors. It may be aggressive yield-seeking, but mortgage real estate investment trusts (mREITs) have been on the climb in the last three months. Those with positive momentum include Hatteras Financial (HTS), Ellington Residential Mortgage (EARN), Invesco Capital Mortgage (IVR), Armour Residential (ARR) and Two Harbors (TWO), CYS investments (CYS) and AG Mortgage Investment Trust (MITT). On the commercial side of the real estate business, Apollo Commercial Real Estate Finance (ARI) shares have also been moving higher in the past three months.

The group has been cheap for a long time, but money now appears to be flowing back into these high-yielding securities.

Ampco-Pittsburgh (AP), meanwhile, is one example of a cheap, boring industrial stock that is finally attracting some investor interest. The stock had tracked sideways for a long time but, over the past three months, it has climbed by a little over 15%. The company makes hardened steel rolls that are used in cold rolling by producers of steel and aluminum. It also manufactures tube heat exchange coils and related heat-transfer products that are used in the power generation and HVAC industries. The stock is still trading just below book value, and its dividend yields at more than 3% right now.

Titan Machinery (TITN) is another old-economy stock that appear to be back in favor. The company sells new and used agricultural and construction equipment that's manufactured under the CNH family of brands, as well as equipment from other manufacturers. The shares have risen a little over 6% in the last quarter, and much of that move has come in just the last month. The stock is trading at just 86% of book value, so it is still at a bargain price, and it could continue to move higher.

Atlas Air Worldwide (AAWW) is another cheap stock that has been on the move lately. The company provides outsourced aircraft and aviation operating services, so its stock floundered when it became obvious that the slowdown in U.S. military movements would hit its bottom line this and last year. Shares have started to recover following last month's solid earnings report, which showed that efforts to diversify away from the military were working. The stock has climbed almost 20% in the last three months, and is still priced at just 78% of book value.

Swift Energy (SFY) may finally be on the upswing, as the company has seen its stock move up by more than 10% in the quarter. Swift is one of the cheapest stocks around, trading at just 50% of book value. The company announced recently that it had found a joint-venture partner to develop its Eagle Ford acreage, and talks also appear on track for selling its Louisiana assets. More than 40% of the Swift share float is sold short, so any good news about this ultra-cheap name could send the stock higher very quickly.

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