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.