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If you’re evaluating potentially oversold stocks that you think may be on the verge of a comeback, one factor to consider is the health of their profitability. We wanted to evaluate stocks that are currently beaten down, trading at oversold conditions measured by RSI(14) < 40, and highly shorted with short float > 10%. From this universe, we ran a DuPont analysis to find those that have seen positive trends in quarterly ROE year-over-year.

[Click all to enlarge]

We broke the ROE equation into three parts:

  • (Net Profit/Equity)
  • (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
  • (Net Profit margin)*(Asset turnover)*(Leverage ratio)

All of the stocks mentioned below have seen rising ROE values for the recent quarter, year-over-year. Then we wanted to analyze the sources of these returns, so we narrowed down the original universe to only focus on companies with the following characteristics:

  • Decreasing leverage, i.e. decreasing Asset/Equity ratio
  • Improving asset use efficiency (i.e. declining Sales/Assets ratio) and improving net profit margin (i.e. declining Net Income/Sales ratio)

Companies passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.

We also analyzed the recent performance of an equal-weighted index of all the stocks mentioned below. As the following chart shows, the list generated a big alpha early on in the month, and then diverged sharply from the benchmark. To access a complete analysis of recent performance, click here.

Given the latest quarter’s health in profitability, do you think this recent selling pressure is warranted or likely to continue? Use this list as a starting-off point for your own analysis into potentially undervalued opportunities. List sorted by increase in quarterly ROE year-over-year. (Note: Data collected on Wednesday afternoon.)

1. ReneSola Ltd. (NYSE:SOL): Semiconductor Industry. Market cap of $799.02M. RSI(14) at 37.12. Short float at 19.36%. Return on Equity increased from -7.10% to 10.41%. When analyzing the sources of return, Net Profit Margin increased from -15.63% to 15.80%. Sales/Assets increased from 0.1400 to 0.2431, while Assets/Equity decreased from 3.2424 to 2.7110 (comparing 3 mo. ending 12/31/09 vs. 3 mo. ending 12/31/10). The stock is currently stuck in a downtrend, trading 8.27% below its SMA20, 10.76% below its SMA50, and 11.46% below its SMA200. The stock has gained 17.8% over the last year.

2. Trina Solar Ltd. (NYSE:TSL): Semiconductor Industry. Market cap of $1.89B. RSI(14) at 37.61. Short float at 11.49%. Return on Equity increased from 7.19% to 12.38%. When analyzing the sources of return, Net Profit Margin increased from 15.58% to 22.64%. Sales/Assets increased from 0.2023 to 0.3010, while Assets/Equity decreased from 2.2798 to 1.8166 (comparing 3 mo. ending 12/31/09 vs. 3 mo. ending 12/31/10). This is a risky stock that is significantly more volatile than the overall market (beta = 3.06). The stock has gained 8.33% over the last year.

3. Core Laboratories NV (NYSE:CLB): Oil & Gas Equipment & Services Industry. Market cap of $4.36B. RSI(14) at 38.82. Short float at 17.33%. Return on Equity increased from 14.36% to 16.10%. When analyzing the sources of return, Net Profit Margin increased from 17.10% to 22.39%. Sales/Assets increased from 0.3067 to 0.3461, while Assets/Equity decreased from 2.7388 to 2.0772 (comparing 3 mo. ending 12/31/09 vs. 3 mo. ending 12/31/10). The stock is a short squeeze candidate, with a short float at 17.33% (equivalent to 19.87 days of average volume). The stock has gained 31.9% over the last year.

4. Monro Muffler Brake Inc. (NASDAQ:MNRO): Auto Parts Industry. Market cap of $917.17M. RSI(14) at 35.32. Short float at 12.22%. Return on Equity increased from 3.51% to 4.05%. When analyzing the sources of return, Net Profit Margin increased from 5.18% to 6.68%. Sales/Assets increased from 0.3622 to 0.3701, while Assets/Equity decreased from 1.8728 to 1.6392 (comparing 3 mo. ending 12/31/09 vs. 3 mo. ending 12/31/10). Risk-averse investors may appreciate that MNRO has a relatively low correlation to the market (beta = 0.48). The stock is a short squeeze candidate, with a short float at 12.22% (equivalent to 11.48 days of average volume). The stock has gained 23.48% over the last year.

Accounting data sourced from Google Finance, short float and all other data sourced from Finviz.

Source: 4 Oversold Short Squeeze Candidates With Encouraging Profit Trends