• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Bruce Kamich
    • Doug Kass
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / U.S. Equity

Keeping the Focus on Small-Cap Bargains

Value plus quality remains the most profitable strategy of all.
By TIM MELVIN Jan 30, 2015 | 02:00 PM EST
Stocks quotes in this article: TWMC, SHOS, SHLD, KELYA, WMAR, SKYW

This week we have looked at using the measure of quality developed by Robert Novy-Marx of the University of Rochester along with other variables that are time tested factors in selecting stocks with the potential to outperform the market. (mea culpa for calling the school Rochester University several times this week)

We also have limited our universe to small-cap stocks based on the latest paper by Cliff Asness, which finds that the small-cap premium is still much in play when you control for quality.

Today, we move to the one I prefer most, price-to-book value. Professor Novy- Marx is apparently a fan as well. In his paper The Other Side of Value he writes that controlling for book-to-market significantly improves the performance of profitability strategies, and that controlling for gross profits-to-assets significantly improves the performance of value strategies." Like chocolate and peanut butter they are good on their own but even together.

I ran the screen this morning and produced a great list of stocks. The current list is of high-quality stocks trading below book value. The largest stock on the list is SkyWest (SKYW) a stock that is a great example of why I don't lose much sleep over stock declines in the short run.

I originally bought this stock around $11 a share and it immediately dropped back down to $7, a hefty loss. Since then it has rebounded nicely and we have a decent gain in the stock. If oil prices stay down here the regional airline should benefit and move still higher. The company's $4.2 billion of assets has produced $1.8 billion in gross profit in the past 12 months and shares trade at about half of tangible book value. So it passes both the value and quality tests right now.

Kelly Services (KELYA) is another old favorite. I bought the staffing company in 2009 when it looked like no one would ever work again and sold it in 2011 for a nice gain. The stock has pulled back in the past year, declining by almost 30% and it is now cheap again at 83% of tangible book value.

Kelly used $1.9 billion of assets to produce $907n million of gross profits so it easily passes out quality test. I have not bought the shares back yet but I probably should on the next pullback in the overall market. The only thing that keeps this stock from passing the perfect stock test is a current ratio below 2. That is offset by the Altman Z-score of a very healthy 4.1 indicating that the company is financially sound.

I am not the only who one who has a hard time buying anything associated with Sears (SHLD) as Sears Hometown and Outlet Stores (SHOS) are down over 40% in the past year. I may have to reconsider as the retailer produced gross profits of $566 million on assets of just $663 million in the past 12 months.

The spinoff company sells home appliances, hardware, tools, and lawn and garden equipment in the United States and they have ben opening new locations at a pretty good clip the last year. According to Franchise Gator, the company is number 12 on the list of top 100 franchises in the United States. The stock is trading at just 61% of book value, so it is certainly cheap at current levels.

There are not a lot of stocks on the list right now. That's consistent with our experience with all the value-oriented screens right now. Most of the names are familiar. West Marine (WMAR) barely makes it with a price to book value ratio of 98%. The marine retailer had gross profits of $187 million on assets of $478 million so it makes the grade as a quality company. Transworld Entertainment (TWMC) makes this list of quality cheap stocks as well with $138 million of gross profit on assets of $274 million. The stock is trading at 65% of book value and about 75% of net current assets, so it is a super cheap stock on just about any measure.

Combining the work of Cliff Asness of AQR Management on quality and small-cap stocks and the equality definition of Robert Novy-Marx produces a solid list of stocks no matter which investing approach you prefer. The research also indicates that value plus quality remains the most profitable strategy of all, especially with the smaller capitalization companies.

Enjoy Super Bowl weekend everyone.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication Melvin was long TWMC, WMAR, and SKYW.

TAGS: Investing | U.S. Equity

More from U.S. Equity

As Carnival, Royal Caribbean and Norwegian Sink, Here's When to Dive In

Ed Ponsi
Jun 30, 2022 1:30 PM EDT

These stocks are priced for an industry-wide calamity, but how realistic is that considering their customer base?

Market Trends in Question as Support Levels Breached

Guy Ortmann
Jun 30, 2022 10:02 AM EDT

The near-term is getting tougher to call as each rally has been short-lived.

Epically Bad First Half, Inflation's Origins, Defense Stocks, Seasonal Investing

Stephen Guilfoyle
Jun 30, 2022 7:34 AM EDT

Is Defense recession proof? Not in 'normal' peacetime, but maybe this time.

This FAANG Stock's Technicals Are at a Summer Crossroads

Bob Lang
Jun 29, 2022 3:30 PM EDT

Summer is a time when this name usually gains momentum. Will it this time?

Kass: Untapped Homeowners Equity and Imbedded Gains Will Be a Ballast to Growth

Doug Kass
Jun 29, 2022 3:00 PM EDT

Homeowners equity has more than tripled in the last decade.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 04:41 PM EDT PAUL PRICE

    First Half Results - Putrid Second Half Results - Likely to Be Much Better

    It's great that we're done with June. 2022 marked...
  • 04:51 PM EDT PAUL PRICE

    We Should Be in for Better Starting Soon

    Window dressing Thursday, the last day of the...
  • 11:56 AM EDT STEPHEN GUILFOYLE

    Stocks Under $10

    Check out what's going on in the Stocks Under $10 ...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2022 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login