Although I try not to waste too much time worrying about what the general market might do, my friends and associates certainly do. This weekend, I fielded a few "What is the market going to do now?" phone calls. The press, of course, was full of predictions, suggestions and guesses about the direction of the market. My answer is always the same. I don't know and I do not think anyone else does either.
However, comments from star investors Sam Zell and Seth Klarman combined with the high market cap to GDP ratio and the low Value Line median appreciation reading are making me think that the conditions are more favorable for a move down than up. And yet I would not be willing to make a bet on it. Klarman and Zell were saying the same thing a year ago, and both indicators were at high levels. The market has just marched higher since then. So suspicions are one thing, and trying to time it all is another.
Nervous investors can help themselves but sticking to just the safest cheap stocks they can find right now. There is a tendency at times to tweak the standards a little bit and buy companies that seem to have great prospects but might also have a little tiny bit more risk in their balance sheets than we would normally tolerate. I confess that this is one of my greatest weaknesses in a bull market, and one I have to vigilant about avoiding.
We can use two simple numbers to help us avoid that temptation. Focusing on the cheap stocks that have high Piotroski F-Scores as well as high Altman Z-scores restricts us to a universe of stocks with solid balance sheets and improving financials. If these fortress stocks decline in a broad market selloff, then it is a lot easier to hit the "buy" button and add to our positions.
I sat down this morning and a ran a screen looking for stocks with an F-score above 5, which is an indication that the company's financials and fundamentals are improving, year over year, and should lead to above average-performance. I then filtered for just those with a Z-score above 2.99, which tells us that the company is not financially distressed in any way.
For the most part, these are not going to be the world's most exciting companies. But, as we have learned in previous corrections, exciting is not always good. Seneca Foods (SENEA) is in the world's most basic business. The company is the leading provider of packaged fruits and vegetables in North America and holds the largest share of the retail private label, food service, and export canned vegetable markets; it distributes to more than 90 countries. Seneca also packs fruits and vegetables for General Mills (GIS) Green Giant line of frozen and canned foods. It is boring but it is safe and cheap. Seneca shares trade at 80% of book value and have an F-score of 5 and a Z-score of 3.55.
West Marine's (WMAR) shares are down a little over 35% so far in 2014. Consumers have pulled back from spending on hobbies as the economy remains sluggish and jobs growth uncertain. Eventually, spending will return to the boating market and West Marine should benefit from pent-up demand. Boaters may delay spending for a bit but they are not going to give up the boating lifestyle forever. When they feel confident, they will spend again. In the meantime, short-term concerns have the stock trading at just 70% of book value. The company is in fine shape financially as it has a Z-score of 3.22 and an F-score of 5.
It is worth noting that every single screen I have run in the past two weeks has included Gulf Island Fabrication (GIFI) in its results. Capital spending cuts in the oil and gas industry are not the best news for a company that builds offshore drilling platforms and the stock has been beaten up a bit this year. From a longer tem perspective spending is delayed not eliminated and this company should recover nicely at some point in the next few years. In the meantime it is cheap at 90% of book value. The F-score is 7 and the Z-score is 4.5, so Gulf Island is in solid financial shape. I am waiting for the stock to drop below 85% of book value. When it does, I will be a happy buyer of this stock.
Of course, I do get nervous about the market when very smart people warn that it is dangerous. My best offense is a good defense and I restrict myself to safe and cheap stocks. I believe this raises my odds of surviving to thrive over the next few years.