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The financial media’s parade of financial analysts frequently advocates buying undervalued stocks. Though they are quick to explain how a stock is cheap, they almost never validate why their cheap stocks are not value traps. To make up for this shortcomming, two quality metrics are provided to help distinguish quality long-term investments from value traps:

  1. 10-Year Average Return on Equity. Sturdy companies should have a history of growing shareholder wealth. The geometric average of a stock’s ROE for the last ten fiscal years provides a way of looking at equity performance over the long term rather than fixating on the last quarter or last year’s results.
  2. The Altman Z-Score. This score places companies into three groups: “safe” (Z-score > 2.99), “grey” (Z-score between 2.99 and 1.81), and “distressed*” (Z-score < 1.81), and is surprisingly useful for identifying bankruptcy risk in the coming year. This method of segmenting companies uses of fundamental (financial statement) data and market capitalization only.** Beyond credit risk prediction, companies with higher Z-scores have been shown to outperform companies with lower Z-scores, in aggregate.

The Altman Z-score was recently (using financial data reported this year) calculated for hundreds of companies with price to book ratios under 1. Low P/B multiple companies which scored in the safe zone are presented below with a 10-Year average ROE:

Low P/B Firms with "Safe" Altman Z-Scores

Ticker

P/B

Altman Z-score

10-Yr Average ROE

Div Yield

HAST

0.14

3.10

5.7%

0.0%

GIGA

0.31

3.39

-11.0%

0.0%

DUCK

0.36

3.41

2.0%

0.0%

CUO

0.36

3.32

3.4%

0.0%

CRV

0.39

3.87

0.6%

0.0%

GTSI

0.42

3.27

2.2%

0.0%

OTCPK:KRSL

0.43

4.91

8.8%

0.0%

JBSS

0.44

3.01

3.6%

0.0%

UUU

0.45

6.59

16.6%

0.0%

TWMC

0.47

3.54

-9.0%

0.0%

TIII

0.47

3.41

-3.9%

0.0%

BPHX

0.48

4.31

-16.9%

0.0%

MTEX

0.53

3.04

5.5%

0.0%

TUES

0.53

3.39

21.9%

0.0%

UFI

0.54

3.66

-9.6%

0.0%

LAKE

0.56

3.00

8.5%

0.0%

SCX

0.57

3.28

0.2%

3.3%

BSET

0.58

4.07

-5.9%

1.7%

HRT

0.58

4.18

8.9%

3.4%

KBALB

0.58

4.01

3.4%

3.4%

CECO

0.59

3.01

14.0%

0.0%

KGJI

0.59

14.56

-59.5%

0.0%

RCKY

0.6

3.06

3.3%

0.0%

SED

0.6

4.13

-9.2%

0.0%

OTCQB:NOBH

0.62

11.06

9.5%

0.0%

CSPI

0.62

3.53

-4.7%

0.0%

TSRI

0.63

6.08

8.4%

0.0%

ELY

0.63

3.03

4.9%

0.7%

MALL

0.64

4.77

5.7%

0.0%

FORD

0.65

4.18

4.4%

0.0%

CBK

0.67

3.42

12.0%

8.5%

BTUI

0.67

3.03

-12.1%

0.0%

PTIX

0.68

3.45

-1.6%

0.0%

KEQU

0.69

3.15

6.3%

4.9%

ANTP

0.69

5.50

0.9%

0.0%

MSN

0.69

4.38

19.1%

0.0%

PDEX

0.69

3.57

-1.8%

0.0%

SKX

0.69

3.72

12.8%

0.0%

AFAM

0.7

4.64

21.3%

0.0%

ASYS

0.7

3.14

2.3%

0.0%

REX

0.71

3.53

9.6%

0.0%

BHE

0.71

4.13

4.1%

0.0%

FLXS

0.72

5.67

6.5%

2.9%

RVP

0.72

2.99

47.8%

0.0%

SKY

0.74

4.67

-7.0%

5.9%

VLO

0.74

3.97

12.5%

2.7%

APT

0.75

12.39

14.5%

0.0%

CVR

0.75

6.63

3.0%

3.5%

QBAK

0.76

5.62

-2.7%

13.3%

SIGM

0.78

3.14

-13.3%

0.0%

AIRT

0.78

6.03

12.8%

3.0%

BG

0.78

3.49

14.7%

1.6%

MOC

0.78

6.01

20.8%

0.0%

MPAC

0.78

6.11

3.9%

0.0%

PSEM

0.78

3.70

2.4%

0.0%

LUB

0.79

3.60

-3.0%

0.0%

ADGF

0.79

3.21

-4.8%

0.0%

ARCW

0.79

13.28

-4.0%

0.0%

OME

0.79

3.14

4.5%

0.0%

ISNS

0.8

5.09

15.1%

0.0%

STLY

0.8

3.12

-0.5%

0.0%

BDL

0.81

3.19

10.9%

1.3%

CRAI

0.81

3.47

9.4%

0.0%

FRS

0.81

3.17

10.9%

3.2%

RIMG

0.82

5.51

13.2%

6.1%

TSO

0.83

4.18

11.6%

0.0%

IM

0.85

5.47

3.1%

0.0%

WMAR

0.85

4.58

-0.1%

0.0%

CRRC

0.86

3.65

9.9%

7.8%

BABY

0.86

3.84

-1.2%

0.0%

FDP

0.86

3.76

11.8%

1.6%

MEA

0.86

3.21

17.1%

0.0%

PRCP

0.86

3.61

1.8%

0.0%

VSR

0.86

4.36

7.2%

0.0%

BKR

0.87

3.74

13.5%

0.0%

AM

0.88

3.33

0.0%

3.4%

PTRY

0.89

4.38

4.5%

0.0%

HOFT

0.89

6.42

9.4%

3.8%

BTN

0.89

3.53

2.1%

0.0%

CAS

0.89

3.16

3.3%

0.0%

LDL

0.89

4.52

2.5%

0.0

SFE

0.89

4.19

-24.6%

0.0%

SVT

0.89

4.56

8.0%

1.7%

TQNT

0.89

5.67

-2.4%

0.0%

FEIM

0.9

3.91

-0.3%

0.0%

OVTI

0.90

4.17

11.6%

0.0%

JOUT

0.91

3.57

-2.6%

0.0%

COHU

0.91

4.53

2.4%

2.2%

ORBT

0.91

3.32

2.2%

0.0%

TLAB

0.91

3.22

-5.4%

1.9%

WVVI

0.91

3.11

6.1%

0.0%

CWCO

0.92

3.91

9.9%

3.7%

INTT

0.92

5.41

-17.0%

0.0%

SPAR

0.92

4.40

14.9%

2.0%

RCMT

0.92

3.70

-9.1%

0.0%

SYNL

0.92

4.94

4.8%

2.5%

SMIT

0.93

5.30

-2.3%

0.0%

CDI

0.93

5.13

2.0%

4.0%

CYBE

0.93

5.60

-1.9%

0.0%

ENG

0.94

3.96

8.5%

0.0%

EPAX

0.94

4.49

30.1%

5.3%

MAXY

0.94

24.89

-6.1%

0.0%

AXTI

0.95

4.47

-13.5%

0.0%

RELL

0.96

4.95

1.0%

1.6%

KSW

0.96

3.46

5.2%

4.5%

PARL

0.96

4.17

3.8%

0.0%

EBF

0.97

4.20

11.0%

4.6%

SNX

0.97

5.35

13.2%

0.0%

LAWS

0.97

3.75

4.4%

3.0%

APOG

0.99

3.03

10.5%

2.9%

OTCQB:CMKG

0.99

3.45

-4.5%

0.0%

QLTI

0.99

12.19

-7.4%

0.0%

There appears to be only the faintest relationship between the P/B ratio (how cheap a firm is) and its return on equity over the last decade (a measure of quality). Among very low price to book ratio stocks, the long-term ROE might be able to inform the long-term attractiveness of value investments.

Three proverbial "50-cent dollars" pop out of this list. Each of Hastings Entertainment Inc. (HAST), Kreisler Manufacturing Corp. (OTCPK:KRSL), and Security Instruments Inc. (UUU) has an attractive return on equity given how cheaply each trades. (I consider a 15% ROE to be fair for stock trading near book value, and lower positive returns are acceptable for dramatically discounted stocks.) Though many of the equity returns are negative or low, the table lists other low price-to-book names with attractive long-term returns.

It is wise to remember that these stocks are cheap because they are scary: This year Hastings Entertainment Inc. shares plummeted 78.4%, Kreisler Manufacturing Corp. fell 11.4%, and Universal Security Instruments Inc. share prices have dropped 32%. They are not for the timid or short-term traders, and any change in market sentiment towards them will likely take years.

* "Distressed" was a label coined by researchers, and should not be taken to mean that any company is bankrupt or in default on the basis of this calculation alone. Credit scoring is not fate, only prediction based on relative past performance of companies grouped by key variables. Time will tell.

** Volatility has be incorporated into a credit scoring model to improve accuracy, but this would reduce the value of a fundamentals-only model for indicating companies for option strategies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.

Source: Ultimate Deep Value Stock Screen