The recent market action has me dipping into the cash hoard just a little bit. I am nowhere near all in, but we have stuck the toe a little deeper into the pond. I was asked yesterday if the recent market action had me ready to go all in, and the answer was a very disappointing "no". We are falling from a very high level, and the PE ratio of the S&P 500 is still around 20. The Russell 2000 may be down 25% from the highs, but the trailing PE sports a triple-digit ratio and for the Nasdaq 100 it's 21.
The market has been going straight up for six years and much of the earnings "growth" was generated by layoffs and buybacks. We are getting closer to an inventory creation event, but we are not yet to the point where I can sing "hallelujah" and be an aggressive buyer.
Looking at the numbers tells us where we are right now. In a database of 5500 domestic stocks, I ran a simple screen that looked for companies that have Piotroksi F-score of 5 or higher and Altman Z scores of 3 or more. Companies that can pass both of these financial tests have strong balance sheets, and business conditions are good and getting better; 718 companies passed that test. When I added a check for valuation, things went off the rails. Just 45 of them trade for 90% of book value or less. That is just a small fraction of the 744 stocks that trade below book value. We can find financially solid stocks with a margin of safety in the financial statements. We can find stocks that trade for less than asset value. Where we are having a hard time is finding many stocks that have both characteristics.
If we go with the basic Walter Schloss criteria and search for companies that trade below book value with low debt levels, high current ratios and insider ownership trading near three-year lows, we get a universe of just 30 names. If we go with perfect stocks and search for companies that trade below book value, are profitable with strong balnce sheets and pay a dividend, we find a lonely little group of just 16 stocks.
It will start to get exciting if markets keep dropping. There are 52 perfect stocks trading between 0.9x and 1.5x book value. If the market keeps falling, we could get fully invested in these historically high return stocks. There are 51 Schloss stocks that trade in that range. There are 97 almost cheap stocks that have adequate F and Z-scores. We are getting very close to major inventory creation event, but we are not quite there yet.
Where it gets really exciting is when we look at bank stocks. There are 80 banks stocks trading below 90% book value right now; 57 of those have an equity-to-assets ratio of 10, the level where I consider a bank's balance sheet to be strong. Currently, there are 157 banks that have strong balnce sheets and trade between 90% and 120% of tangible book value. I would be doing a happy dance all around the office if the current selloff continued and expanded the number of Trade of the Decade stocks that are cheap enough to buy with abandon. Currently my buy list is about 25 stocks that are safe, cheap and have activist/specialist investors involved. Getting that number up to 50 or more again would bring that final move to the Keys schedule forward by a few years.
I have been sitting and waiting, not always patiently, for a significant selloff for some time now. While the community bank part of my portfolio has stayed pretty fully invested, that deep value portion has been consistently at 50% or more in cash. I have further suffered by having too much energy-related stuff in the portion that was invested. Now I am finally starting to see non-energy and resource stocks get close to cheap enough to start committing the cash in a big way.
For the record, my biggest buy yesterday of a stock big enough to mention here was a large addition to my Unisys (UIS) position. The stock has continued to sell off in spite of a big change in the sales culture at the company and a $200 million annual savings from the cost cutting program that should be at full run rate by this time next year. That's $4 a share of almost half the current stock price. They also have a new cybersecurity product that is winning awards and industry recognition that can drive sales and profit growth. Just yesterday, the company announced that it will provide enterprises with the award-winning Unisys Stealth micro-segmentation security solution on the Amazon Web Services (AWS) Cloud, available for customers to immediately acquire and deploy from the AWS Marketplace. I expect that be one of the first of many Stealth-related announcements in 2016.
We are not there yet. But we are closer than we have been in a long time.
