This Year's Jewels in Last Year's Junk

 | Jan 03, 2017 | 5:00 PM EST
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As we start the new year, I found myself spending time over the weekend looking through the 2016 garbage bin. Although the market muddled along for much of the year, it put on quite a show in the last eight weeks as the election results gave it some turbo-power driving the S&P 500 to finish up 12% and the Russell 2000 index to rise by 21%. I thought it might be useful to see if we can find any stocks that just did not participate in the late rally. For deep-value types like myself, the loser list is far more interesting than looking into the top gainers of the past year.

I am well aware that many stocks that did not participate in the runup fell short for excellent reasons. Some of these companies might be over leveraged, have a bad business plan or products that are out of favor right now. To eliminate the duds I limited my list to just those companies that had a Piotroski F-score of 6 or more.

Two names that jumped off the screen for me were the gun stocks Storm Ruger (RGR) and Smith & Wesson Holdings (SWHC) . I know that the common thought process is that gun sales will slow since there is no longer a threat from an anti-gun administration and, thus, there won't be as much stocking up. That is probably right, but there will still be decent demand for guns and ammunition, and we may still see some localized panic buying as I suspect many states will attempt to pass much stronger gun laws now that the Feds may be backing away a bit.

Both companies have excellent fundamentals. Ruger has an F-score of a perfect 9 and Smith & Wesson earns a score of 7. Both stocks are cheap as well with EV/EBIT ratios well below average. Ruger has a ratio of 6.6 and Smith Wesson shares trade for a multiple of 6.1. Ruger pays out 40% of earnings each quarter, so the dividend is variable, but you do get paid to wait for the stock to move higher over time. Smith & Wesson does not pay a dividend right now as they have been using their cash flow to make acquisitions. The company is also changing its name to American Outdoor Brands to reflect its entire product line better. Gun stocks will probably be quite volatile, but patient investors could see private equity-like returns over the long haul.

Span-America Medical Systems (SPAN) also makes the list of under-performers. This company makes bedding and seating products for the medical industry and also sells furniture and foam products to the consumer goods and industrial market. The company is in solid financial shape with an F-score of 8, and the share is also cheap with an EV/EBIT ratio of just 7.6. The stock has a yield of 3.51%, and management has increased the payout by almost 9% annually over the past five years. Span-America lost a large retail customer for its consumer-bedding products mid-year, but they expect to make up for it with increased sales of higher-margin medical products in 2017. Insiders own about 18% of the company, so they have a vested interest in seeing the business and the share price improve over the next several years.

Office Depot (ODP) is another potentially interesting company that has lagged the market but has an F-score indicating financial strength and improvement. The stock got hit hard when the planned merger with Staples fell apart, but this company has made some real improvements. They decided to sell their international operations and focus on the North American markets. They overhauled their supply chain system and have focused on cutting costs. Office Depot has been rewarding shareholders with stock buybacks and dividends and right now the shares are yielding 2.21%. Through the third quarter, they have repurchased more than $80 million of stock and still had another $170 million to buy under the current plan. The company has an F-score of 7 and an EV/EBIT ratio of just 6.8, so it appears to be both safe and cheap right now.

I am far more likely to be digging in the garbage can than the penthouse for stock ideas. The big F-scores and low valuations of stocks the market have been overlooking could lead to high returns for aggressive but patient investors in 2017 and beyond.

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