Today, I want to take another look at the 2016 trash can to see if we can find any other overlooked stocks that might be worth consideration for a rebound in 2017. Yesterday, I measured financial stability and safety using the Piotroksi F-score. Today I want to use the Altman Z-score, which measures the financial strength of a nonfinancial company.
The measure was originally developed by Edward Altman of the NYU University Stern School of Business as a way to predict corporate bankruptcies. The lower the score, the more likely the company is to experience financial distress in the next two years. We can stand that on its head and look for those that have a high score, indicating little-to-no chance of financial difficulties, to find companies strong enough to survive until they can thrive again. Being a cheapskate, I limited my search to just those stocks that have low Enterprise Value to Ebit ratios, indicating we can buy the shares at a bargain price.
The first thing I noticed was that all of the stocks I mentioned yesterday made the grade. Office Depot (ODP) , Sturm, Ruger & Co (RGR) , American Outdoor Brands Corporation (AOBC) (formerly Smith and Wesson (SWHC) )and Span-America (SPAN) also have high Altman Z-scores, so they have a large margin of safety.
Homebuilder D.H. Horton (DHI) makes the list of cheap stocks in excellent financial shape. The company is the largest homebuilder in the United Sates, as measured by volume. The company has operations in 78 markets in 26 states across the country and focuses on entry level and move-up buyers. Only 7% of the homes they sold last year sold for more than $500,000, so it is clearly leaving the luxury market to other competitors. D.H. Horton also offers mortgages and title insurance to their homebuyers.
In their most recent investor presentation, management said that current land inventories supported double-digit sales and earnings growth for the next few years. If they are correct, then the stock is a bargain at current levels, as the EV/Ebit ratio is just 9.1, well below the average multiple right now. The company is in solid financial shape, with an Altman Z-score of 4.6. If we do see a strengthening economy, then the low end of the housing market will pick up, and this company will surprise to the upside in 2017.
STRATTEC Security (STRT) is in a pretty basic business. It makes locks and key for cars and trucks. It produces things like steering column and instrument panel ignition lock housings, latches and lift gate systems that it sells to original equipment manufacturers. The stock has fallen by 28% over the past year, as the company had missed earnings expectations three quarters in a row before posting a positive surprise in the latest quarter. The company earns an F-score of 4.13 and has an Ev/Ebit ratio of 9.1, so the stock may be a bargain with a decent margin of safety. The one caveat here is that it is dependent on decent new car sales, so the strength of the economy is a huge factor for this company.
Marcus & Millichap (MMI) is a commercial real estate brokerage with operation in the U.S. and Canada. Business is pretty good for the brokerage firm, as the most-recent quarter showed revenue growth of 8.9% with sales in the large transaction market jumping ahead by over 25%. The company is in great financial shape, with an Altman Z-score of 9.2 and the stock appears to be cheap, with an Ev/Ebit ratio of just 7.6.
MMI is going to be dependent on the performance of commercial real estate. In its latest outlook, the company was cautiously optimistic, saying "Ultimately, the third-quarter survey reiterates that investors still consider commercial real estate a significant element of their investment strategy and they still see opportunities. Nearly three-fourths of respondents, 77%, either strongly or somewhat agree that commercial real estate offers favorable returns [vs.] other investment classes. Also, an almost equal number of respondents, 75%, do not think it is a better time to invest in the stock market as compared to commercial real estate." If the company is correct, it should be a good year, and the stock price should move higher.
Shopping the trash bin can be profitable, but always keep in mind that some companies are in the trash for good reasons. Focus on those that have strong balance sheets. Using Altman Z-scores can help you find those that have the strength to recover.