For Those More Sanguine Than I

 | Nov 20, 2013 | 2:00 PM EST
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Last night, I was berated by an old friend for continuing to predict that the Orioles will land an ace pitcher and win the American League East next year -- and for spending too much time talking about what not to buy in the current market. Although I think that latter topic continues to be a valid discussion, I think I have made my case that investors should avoid those companies with poor fundamentals and financials, as measured by F-scores.

So, today, I want to spend a little time looking for companies that are hitting on all cylinders that are outside my usual deep-value universe. These might be worth consideration by investors that are more sanguine about market conditions and valuation levels than I.

I combined two of my recent theories -- using factors from the balance sheet, as well as income and cash-flow statements -- to identify potential winning stocks. I have hammered home my point about the F-score for some time, so we will use that and look for stocks of companies whose financials produce an F-score of 7 or higher. Such a figure would indicate a high probability of future outperformance. These companies are seeing consistent improvements across their financial statements, and the strong results should help drive higher performance or, at least, better performance than that of the broad market.

I am going to combine that with research from Professor Robert Novy-Marx of the University of Rochester. In his paper, "The Other Side of Value," the professor produced an interesting finding: When companies have a high gross operating profit as a percentage of assets, they produce returns that are similar to those that trade below book value. I like the concept, as focusing on gross profit allows you to look at the real profitability of a company before you move down the income statement and are able to pollute the numbers with write-ups, writedowns, adjustments and assumptions.

The combination screen has produced some very interesting names, and investors without my deep-value bias might want to consider these as long-term holdings.

The largest company to make the cut is Novo Nordisk (NVO), the Danish drug company that focuses on diabetes. The firm produced about $11 billion in gross profit on $11 billion of assets, and it has an F-score of 7 right now. Unfortunately diabetes is going to be a growth market for a long time, so this stock could be an excellent long-term holding.

Franklin Covey (FC) has a high F-score of 8. According to the company, it offers training and consulting to address things like leadership, execution, sales performance and education problems worldwide. I have no idea what all that means, but companies and individuals are using its services and business seems to be very good. The company produced $129 million in gross profit on assets of just $176 million -- a very high ratio.

Away from that, apparently there is big money in lawn care these days. Toro (TTC) makes equipment and supplies needed to take care of lawns, golf courses, sports fields and other big patches of lawn and landscaping. It also makes irrigation systems to keep all these plants and grasses growing so they can be cut again next week. Just to make sure it has all bases covered, Toro also manufactures and sells snow blowers so you can uncover your grass in the winter months. With gross profit above $700 million on assets of $1 billion, it's a very profitable business -- and the F-score of 8 makes it even better.

Big Five Sporting Goods (BGFV) missed estimates last quarter, and Wall Street punished the shares accordingly. But the always highly accurate analysts might be missing the bigger picture with this stock. The Western U.S. retailer is turning out gross profit of $326 million on assets of just $409 million, which is quite impressive. The F-score is an 8, indicating strong an improving financial conditions. Golf, tennis, hunting, fishing and other sports fall into the addictive-lifestyle classification, and if consumers have money to spend on these items, they will spend it. There are plenty of Big Five locations in which those folks can spend that cash, too: The company operates 420 stores across 12 Western states.

While I can't fit any of these stocks into my deep value class of stocks, they should be of interest to more growth-oriented investors. Using the theories of Piotroski and Novy-Marx can certainly help you find stocks that are profitable and have market-beating characteristics. As my dear old mother never actually said, there is more than one way to bake a cake.



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