Deep Value Abounds

by: Alan Brochstein, CFA

With fewer than four months to go, stocks haven't differentiated themselves from cash as far as an impact on portfolios, returning just 0.4% as measured by the S&P 500. If you are like me and expecting stocks to make a nice run into the end of the year, or even if you are cautious, I think that smaller value stocks offer a great entry here. There are many stocks that trade close to tangible book value yet are profitable and have strong balance sheets. Poor liquidity since the "Flash Crash" is giving investors an opportunity in my opinon. While the summer has been tough on smaller stocks, YTD performance for Small-Cap Value (as measured by the Russell 2000 Value Index) has been pretty good: +3.84% through 9/3, despite an almost 10% pullback in the three months ending 8/31. So, Small-Cap Value seems capable of continuing to provide potential upside while also offering downside protection.

I ran a screen of the Russell 3000 in order to highlight potential opportunities. Here is what I did:

  • P/TB < 1.5
  • Profitable over last year
  • Net Debt to Capital < 5%

Starting with almost 3000 stocks, the list was narrowed to 200, which is way too many to list here. So, I have included a link to the file: Download R3000 Deep Value 090310. Note that I highlighted tickers of companies that are owned in either of my model portfolios and the names of those that are not owned but are on my 100-member Watchlist. The list is sorted by GICS sector and then by P/TBV. I can't promise that my data source is completely accurate, so let me know if you see anything funny!

Interestingly, every single economic sector was represented, with one sector way overrepresented: Financials. This is interesting, as many of these names aren't particularly credit-sensitive. Plus, there has been some M&A recently (Wesco (NYSEMKT:WSC) and American Physicians (NASDAQ:AMPH)). As an aside, Financials have been disappointing but appear to have regained their footing after being the only sector to score a 52-week low during the recent correction. So much of the market cap is in the big banks, which no one seems to want to own despite improving credit and super-steep yield curves. The sector makes up about 16% of the $10 Trillion market cap of the S&P 500, making it the second largest after Technology. 7 companies have market caps in excess of $50 billion and total $800 billion (about 1/2 the value). The only one that isn't credit sensitive, at least not directly, is recent addition and #2 after JP Morgan (NYSE:JPM) in terms of contribution: Berkshire Hathaway (NYSE:BRK.B). So, it's not that surprising, perhaps, that 81 of the 200 names come from this sector. Many of these companies are insurance companies and somewhat tough to understand for the average investor (and for me!).

As I mentioned, I have included a link to the entire list. I will list by sector those with market caps in excess of $1 billion:

  • Energy: Nordic American Tanker (NYSE:NAT)
  • Materials: Century Aluminum (NASDAQ:CENX) and Thompson Creek Metal (TC)
  • Industrials: Atlas Air Worldwide (NASDAQ:AAWW)
  • Consumer Discretionary: Footlocker (NYSE:FL), Men's Wearhouse (MW) and Signet Group (NYSE:SIG)
  • Healthcare: Universal American (NYSE:UAM)
  • Financials: Too many to list (22)
  • Technology: Ingram Micro (NYSE:IM), Micron (NASDAQ:MU), TechData (NASDAQ:TECD), Vishay (NYSE:VSH), Fairchild Semi (NYSE:FCS), International Rectifier (NYSE:IRF), Western Digital (NYSE:WDC) and AVX (NYSE:AVX)

The entire list has a median market cap of $341mm and a forward PE of 12.5X. So, there are plenty of market caps ranges and sectors from which to choose. I definitely find these stocks to be good hunting grounds and own 5 names (out of 20 slots) in my Top 20 Model Portfolio. For those willing to do the work (note to self: get cracking!), it seems like there are many Financials worth checking out. I find some of the more cyclical sectors to be most interesting: Industrials, Materials and Technology.

Disclosure: Long HAYN, CRDN, APOG, ATMI and MFLX in the Top 20 Model Portfolio and FL in the Conservative Growth/Balanced Model Portfolio