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One way to find stocks with a better chance to outperform the market is to look for value stocks that, for one reason or another, have fallen out of favor, but are starting to show some strength. Those stocks would have to show stable financial conditions and generate strong free cash flow. However, in order to find such stocks, a technical analysis with an RSI indicator can be of great assistance for investors.

I have elaborated a screening method, which shows stock candidates following these lines. Nonetheless, the screening method should only serve as a basis for further research.

The screen's formula requires all stocks to comply with the following demands:

  1. The stock is included in the Russell 3000 index. Russell Investment explanation: "The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. The Russell 3000 Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are reflected."
  2. Price to free cash flow is less than 11, (many investors prefer using free cash flow instead of net income to measure a company's financial performance, because free cash flow is more difficult to manipulate. Free cash flow is the operating cash flow minus capital expenditure).
  3. Total debt to equity is less than 0.7.
  4. RSI (14 days) is above 30 and RSI (14 days) was below 30 in one of the last 3 days. (The Relative Strength Index (RSI) is an oscillator that measures current price strength in relation to previous prices. The classic way to interpret RSI is to look for oversold levels below 30 and overbought levels above 70. When the RSI crosses above the oversold line (30) it is considered a buy signal).

I used Portfolio123's screener to perform the search. After running this screen on October 05, 2012, I obtained as results for the 3 following stocks:

Data: finviz.com

Avnet, Inc. (NYSE:AVT)

Avnet is one of the world's largest industrial distributors of electronic parts, enterprise computing and storage products and embedded subsystems, creating a vital link in the technology supply chain. The company says its cost-effective services and solutions are vital to a broad base of more than 100,000 customers and 300 suppliers. The company was founded in 1955 and is headquartered in Phoenix, Arizona.

Avnet has low debt (total debt to equity is 0.55) and its price to free cash flow for the trailing 12 months is only 10.23. The company has a very low forward P/E of 6.28. Among the 13 analysts covering the stock, five rate it a strong buy, five rate it a buy and only three rate it a hold. On October 01, 2012, Avnet announced that it has closed the acquisition of the Magirus Group, a leading pan-European distributor of data center solutions and services.

Through its professional services portfolio and knowledge of the IT sector, Magirus enables business partners to take new technologies to market in 11 markets throughout Europe and the Middle East. This acquisition is expected to be immediately accretive to earnings and achieve Avnet's return on capital goal of 12.5% within two years.

The AVT stock seems to be a good investment right now.

Chart: finviz.com

Coinstar, Inc. (CSTR)

Coinstar, Inc. is a leading provider of automated retail solutions offering convenient services that make life easier for consumers and drive incremental traffic and revenue for retailers. The company has approximately 38,500 Redbox DVD kiosks and 20,200 coin-counting kiosks in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants. The company was founded in 1991 and is headquartered in Bellevue, Washington.

Coinstar has relatively low debt (total debt to equity is 0.66) and its price to free cash flow for the trailing 12 months is very low at 5.63. The average annual earnings growth for the past 5 years has been very high at 40% and the average annual earnings growth estimates for the next 5 years is also very high at 18.64%. The company has a very low forward P/E of 8.60. On September 20, 2012, the company announced that it was ranked 15th overall on Fortune Magazine's 2012 "100 Fastest-Growing Companies" list. For the third consecutive year, Coinstar has ranked in the top 100 reflecting the company's strong growth. Coinstar has jumped more than 45 spots since 2010 when it was ranked 61. The CSTR stock seems to be a good investment right now.

Chart: finviz.com

Synaptics Inc. (NASDAQ:SYNA)

Synaptics is a leading worldwide developer of custom-designed user interface solutions for mobile computing, communications and entertainment devices. Synaptics products emphasize ease of use, small size, low power consumption, advanced functionality, durability and reliability, making them applicable to a multitude of markets, including mobile phones, notebook computers, PC peripherals, and portable entertainment devices such as MP3 players. Synaptics was founded in 1986 and is headquartered in Santa Clara, California.

Synaptics has almost no debt at all (total debt to equity is only 0.01) and its price to free cash flow for the trailing 12 months is very low at 8.63. The average annual earnings growth for the past 5 years has been very high at 23.5% and the average annual earnings growth estimates for the next 5 years is 12.5%. On August 02, 2012, the company announced that its cash flow from operations for the fourth quarter of fiscal 2012 was $21.7 million, and the company used $28.2 million to repurchase one million shares of common stock. Cash flow from operations for the fiscal year was $101.4 million, and $61.7 million was used to repurchase 2.4 million shares of common stock. The SYNA stock seems to be a good investment right now.

Chart: finviz.com

Source: 3 Oversold Stocks Ready To Bounce