Academic Research Reveals Strong Stocks

 | Aug 24, 2016 | 12:00 PM EDT
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Now that we have looked at the earnings torpedoes that have the potential to blow up your portfolio, let's go back and look at the stock that the Tozzi Financial Center at the University of Michigan thinks are solid value picks that might lift the value higher.

The Value 40 Fund identifies stocks using value, momentum, quality, predictability, smart money and other factors based on academic research to identify potential winning stocks, and it has worked as well on the upside as the torpedo list has to the downside. The fund has outperformed the S&P 500 in 10 of the last 12 years, often by a very wide margin. Given that the market has gone up for more than seven years and is perched at lofty valuations, it is interesting to see what stocks are on the current list.

As it has been for some time, the sector most represented in the Value 40 Fund is community banks. I have been shouting from the rooftops for years about this sector, and most of the time people react like I am the mad uncle spouting nonsense. Community banks are small, they are boring, they are illiquid but they are very cheap and there is a multidecade consolidation occurring that still has a long way to go.

Just last week, Bill Hickey of Sandler O'Neill commented in Bloomberg articles about what is going on in the community bank sector. "The regulatory pressures forcing small banks to sell can have an unfortunate effect on local economies," he said concluding his remarks by telling Bloomberg, "We're going to see activity in the second half of this year that will outpace the second half of last year. If the shape of the yield curve doesn't change significantly, I think 2017 will be a big year for bank M&A." The trade of the decade is happening now and avoiding community banks in favor of high-multiple dreams and day-trading systems is just plain foolish.

A few of my favorite banks were among the 17 that made the list. Citizens Financial Group (CFG) is one of the cheapest large regionals at 95% of tangible book value. Eagle Bancorp of Montana (EBMT) is a stock I have owned for several years and unless it is taken over I expect to own it for many more. I picked up shares of Tinton, N.J.-based Two River Bancorp (TRCB) at just under book value and it has performed nicely so far.

The list has a pair of maritime energy shippers this month. GasLog (GLOG) is a shipper of liquefied natural gas. LNG shipping has slowed as oil and gas prices fell, but the company has done a great job of refinancing the fleet and shoring up the balance sheet with debt and equity offerings in 2016. On a recent conference call, management said they think we may see a shortage of LNG vessels develop in a few years as a weak spot market has pretty much eliminated fleet expansion.

Overseas Shipholding (OSG) has a fleet of 79 vessels used to transport crude oil and petroleum products around the world. Right now, 55 ships operated in the international flag market and 24 operated in the United States, but the company has announced plans to spin off the international operations as a separate business. CEO Capt. Ian Blackley said on the recent conference call that "We continue to make good progress toward separating our international and domestic businesses. By creating two independent public companies, with an increased ability to focus on their own business, we believe each will be better positioned to enhance shareholder value." The stock is trading at just 50% of book value, so the upside here could be tremendous.

Investors looking for yield should note that Chimera Investment (CIM) makes it into the Value 40 Fund based on the criteria the school uses to spot value. Chimera is a mortgage REIT that invests in residential mortgage-backed securities, residential mortgage loans, commercial mortgage loans and other real estate-related securities. The shares trade right around book value and yield 10.22% at the current price. If rates do indeed stay lower for longer, mortgage REITS could end up being a surprise winner for the rest of this year and well into next as well.

The Tozzi Financial Center at the University of Michigan put financial theories into practice and the results have been strong on both the long and short sides. It is worth the time to print out the list each month and look for ideas that can make you money and help you avoid those risky stocks that could create a permanent loss of capital.

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