During our unscheduled market holiday, I spent a lot of time doing research using Piotroksi scores. The F-score model has been a valuable tool in my arsenal for uncovering value stocks with high appreciation potential, and I am looking at new ways to use the model. But, as we all know there is certain amount of validity to that old adage, "If it ain't broke, don't fix it." The original research paper that introduced the model by Professor Joseph Piotroski was focused on stocks trading below book value ranked by F-score. Those with high scores outperformed the overall market by a wide margin.
With that thought in mind, I sat down and ran a basic screen. Using the model, I looked for stocks with F-scores above 6 that trade below book value. In my first version of the screen, I added some financial-strength criteria and only included those companies with a current ratio above 2 that own as much as they owe. This should give us a list of financially strong companies that are cheap and have improving fundamentals and prospects.
My first observation here was a familiar one. As the market has churned higher, the list of companies that make the cut has shrunk rapidly. There are only 134 U.S.-listed names that fit the bill. Only 31 of those have more than $100 million in total market capitalization, and only seven have a market cap larger than $1 billion. There simply aren't very many solid companies with good fundamental prospects that trade below tangible book value at the moment. That is something of a red flag to me in terms of overall stock-market potential over the next several months.
The largest attractive company is an old friend. I have owned Rowan (RDC) before, and I think the company is well positioned for the future. The firm has divested its non-core land drilling and manufacturing division, and is now focused on offshore drilling rigs. Rowan built three ultra-deepwater rigs without contracts, and it looks as though the gamble is going to pay off for the company and its shareholders. The first of the new rigs is now under a three-year contract with strong day rates.
The stock has been down this week after missing the always highly accurate analyst estimates. The stock now trades at just 90% of tangible book value and has a Piotrokis score of 6. Given the offshore and deepwater focus of the company, in my opinion the likelihood of a takeover will increases as the stock becomes cheaper. Rowan has very little debt and a solid balance sheet. Given the growth prospects of deepwater drilling, an acquisition would make sense for several larger competitors. Given the lack of leverage on the books, I also wouldn't rule out a potential financial buyer, such as a private equity fund.
Dawson Geophysical (DWSN), an energy-related company, is inexpensive based on asset value. It also sports a high F-score. The company acquires and processes seismic data for the oil-and-gas industry. Lower utilization and reimbursement rates put pressure on revenues in the third quarter, but management has said it expects conditions to improve for the rest of the year. We will find out next week, when the company is scheduled to report Monday.
Dawson has done a good job of transitioning from natural-gas research to more oil-related seismic services. It is also expanding into Canada and expects operations to begin in the Great White North next year. Last year, Dawson spent a lot of money expanding its equipment portfolio and adding new crews, and 2013 looks as though it may mark the start of a solid payoff. The stock trades a little bit below tangible book value, and it has an F score of 8, so the fundamentals are already beginning to improve. Dawson has minuscule debt and a strong cash position, so it is well-positioned to grow as the economy recovers and as oil-and-gas demand picks up.
We're currently seeing a very limited list of cheap stocks with solid balance sheets and high F-scores. Energy names dominate the list of larger-market-cap stocks, and this makes sense, since this is one of the cheapest sectors right now. As we have increasingly found over the last two years, the really interesting companies are the micro-caps that are not in the tradable indices or in ETFs.