Appreciating the Undervalued

 | Sep 25, 2013 | 2:10 PM EDT
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I was so caught up in studying the new-low list that I forgot to follow through on Monday's column. The University of Michigan's Ross School of Business not only has a list of stocks you should avoid, they list 40 stocks they believe are undervalued. They do not reveal exactly which metrics they used, but the website says they use value, momentum, quality and predictability. It is a combination of several successful academic theories and it produces an interesting list of stocks that might appeal to long-term investors. According to the website, the screen has beaten the market handily in eight of the last 10 years.

It's easy to see that momentum and value are heavily weighted in the 40-stock list, as many of them are former deep-value stocks where the price has begun to improve. It was not long ago that Bassett Furniture (BSET) traded at a fraction of book value and was wildly out of favor on Wall Street. The company is firing on all cylinders now, with three straight quarters of strong sales growth. The stock is now at a small premium to book value. Insiders have been buying the stock outright and exercising options and keeping the stock, so that's another academic theory at work. The company has plenty of cash and little debt and seems to have put the recession in the rear view. Basset is doing much better than many other consumer-related companies are.

The list has a few little banks, which come as no surprise to me at all. Let's look at two from opposite ends of the banking spectrum. Monarch Financial Holdings (MNRK) is a little bank with 11 branches, 15 residential mortgage offices, and one investment-services office in the Norfolk/Virginia Beach area. It also operates two full-service banking offices and two residential mortgage offices in the outer banks of North Carolina, as well as 28 additional residential mortgage offices outside of its primary banking market area. The bank is in great shape, with nonperforming assets of 0.29% of all assets and an equity-to-assets ratio of more than 10. The stock trades at 1.2x book value and has momentum on its side, with shares up almost 40% this year.

Parke Bancorp (PKBK) has six branches in New Jersey and one in the greater Philadelphia area. It has about $740 million in assets. The stock is much cheaper than Monarch at 75% of book value and for good reason. The loan portfolio is a mess, with non-performing loans at more than 7% of total loans and nonperforming assets at a staggering 9% of total assets. It has excess capital, with an equity-to-assets ratio of a little over 13, but asset quality has been slow to improve. This one has more of a longshot feel, but if it succeeds in getting its house in order, the upside could be huge.

There are many small insurance stocks on the list, including Eastern Insurance Holdings (EIHI), which announced a takeover bid Tuesday at a large premium. This stock was one of my top picks for 2011, and it has more than doubled thanks to the acquisition offer. This is going to be repeated throughout the industry over the next few years as smaller life and property, and casualty insurance companies are very cheap compared to historical valuation. It is worth your time to go to the Ross School's website and run through the insurance picks one by one.

For fans of sin stocks, Rick's Cabaret (RICK) makes the grade as a Ross School cheap stock. Rick's is the only publicly traded operator of "gentleman's" clubs. The stock trades at 12x earnings and 1.3x book value, and business is apparently pretty good. The CEO and CFO like what they see as much as the customers do, and they have been buyers of the stock over the past few months.

Star Gas (SGU) makes the grade as well, as this remains one of my favorite long-term income stocks. The propane company is not going to set anyone's portfolio on fire, but it will continue to roll up Mom-and-Pop propane dealers and pay a strong dividend. The stock yields 6.75% and is a good fit for most income investors in addition to the school's value stocks.

Tracking the academics makes a lot of sense. They have proven they can outperform, and they are willing to publish their stock lists. It just makes sense to check the website regularly.

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