It's no secret that it's been a tough few years for value investors, with bargains hard to find outside of some REITs and small banks. But I ran my favorite "safe-and-cheap" screen yesterday and two interesting stocks popped out.
Now, this model looks for stocks that trade below tangible book value, but that also have Altman Z-scores and Piotroski F-scores indicating that the company can survive and even thrive under current economic and market conditions.
I run the screen and buy the 50 cheapest stocks that it finds in terms of price to tangible book value. However, this isn't a long-term buy-and-hold model, as I rebalance it quarterly. I'll dump stocks if their F- and Z-scores fall below my safety level, or if a name suddenly trades at above book value. It's cigar-butt investing at its finest!
I also run both manufacturing and non-manufacturing Z-scores as part of this screen. I'm looking for maximum safety, but the basic Z-score can often overstate the soundness of a non-manufacturing company's balance sheet.
That said, I use a lower threshold for Z-score cutoffs these days, based on what Z-score creator Edward Altman said earlier this year in an interview with the CFA Institute's Larry Cao. Altman said: "We now think the most important attribute of the Z model is the probability of default (PD), not the zone classification -- safe, gray, or distress."
As a result, I've dropped my Z-score cutoff for adequate safety to a 2.0 reading or higher. However, I won't bend even a little on the Piotroski F-score, which must be 6.0 or higher for a company to make it into my model portfolio.
The portfolio is about 81% invested right now, with a very strong small-cap bias. You probably can't manage institutional dollars with this screen, but it should work very well for individual investors who are willing to sacrifice instant liquidity and popularity for profits.
Here are two stocks that the screen favors:
CPI Aerostructures (CVU)
This aeronautics stock has gotten beaten up over the past year by U.S. Air Force talk of plans to discontinue the A-10 warplane.
CVU has a large contract to supply the A-10 with wing components, but the idea of discontinuing the plane ran into stiff resistance in Congress. That means the program will apparently remain in place longer than expected, which would be something of a windfall for CVU.
But even if it doesn't, CVU is winning contracts for other military and commercial aircraft. The firm is also working on airframes for unmanned surveillance aircraft, which should represent a growth industry in the decades ahead. The company's backlog also increased during the latest quarter, while CVU continues to grow the commercial side of its business.
Add it all up and while there isn't a lot of certainty surrounding this company right now, there is a lot of value. The stock trades at just 86% of book value, with a 2.0 Z-score and 6.0 F-score.
Kelly Services (KELYA)
Temporary-employment firm Kelly Services also makes my list of safe-and-cheap stocks.
KELYA recently reported a strong first quarter, with earnings more than doubling from the year-ago period. Management also hiked the dividend by 50%, so the stock now yield 1.64%.
Kelly also has a 6.0 F-score and 3.80 non-manufacturing Z-score, so it has a margin of safety. But the stock is cheap right now, trading at just some 85% of book value.
Lastly, it's worth noting that KELYA showed up in my "value-momentum" portfolio, as the stock appears to be gaining favor with institutional investors.
The Bottom Line
I've been rebalancing many of the my portfolios as we hit 2016's midpoint. I have to say that I welcomed the extra work, as it gave me a reason to avoid much of the Brexit and end-of-the-world chatter that has filled the media this week.
I thought about posting a spreadsheet of my entire "safe-and-cheap" portfolio in this column, I but decided to go with the "Teach a Man to Fish" approach with this model. After all, the portfolio's median market cap is about $30 million, meaning that most of its components are too small to talk about on Real Money. (We don't like to write much about stocks with sub-$100 million market caps because they're often too volatile.)
Still, the two stocks highlighted above should give you some indication of the type of companies that this screen will uncover. And if you're really interested in micro-cap deep-value investing, you can find plenty of free or paid screening tools online that can help you find more stocks that meet this screen's simple criteria.
