5 Simple Rules That Make Bargain Hunting Easier

by: Mark Krieger

The efficient market theory is just plain hogwash. In bonehead English, it simply implies that all information regarding a company is accurately reflected in its current share price. If that was actually true, investors like Warren Buffett would be holding a tin cup. Case in point, Netflix (NASDAQ:NFLX); just one year ago, was at the top of its game sporting a $300 price quote. Today, those same shares are changing hands at the $70 mark. Why would Mr. Market make that paramount of a mistake in its assessment abilities? Because Mr. Market is controlled by fear and greed, and in the end, he is just as fragile and mortal as you and I, and is especially prone to allowing huge positive and negative excesses.

The key is to eliminate the emotion and noise on stocks that the market seems addicted to and focus on five simple barometers that enable the stock selector to easily take advantage of the disconnect between market value and intrinsic value: (1) Is the company expected to be cash flow positive in the next 12 months? (2) does it have more cash than debt? (3) Is it priced below book value? (4) do insiders own more than 5% of the shares and are they making open market purchases? They need skin in the game to ensure their interests are aligned with the shareholders' best interests. T Boone Pickens' famous quote,

CEOs who own few shares of their own stock have no more feeling for the average shareholder than they do for the baboons in Africa.

brings that point effectively home. (5) does the company believe in itself enough to buy back its own shares in the open market?

Here are a noteworthy few that deserve your attention:

Fuel Systems Solutions (NASDAQ:FSYS): the shares were decimated due to a surprise first quarter loss and lack of guidance (especially troubling), but that creates huge opportunity for a move higher, especially when its second quarter earnings are reported and guidance is finally revealed (dismal estimates of earnings of 10 cents on sales of $105 million should be extremely easy to surpass).

The last time the shares dropped to these oversold levels, they nearly doubled in less than a three month period, and history tends to repeat itself. The negative take; with $80 million in cash and no debt, it is perplexing why there has been no talk of initiating a stock buyback program. Remember, they raised $60 million by selling 2 million shares in a recent secondary offering at a price of $30 per share. Now they could buy those shares back at half price.

Luby's (NYSE:LUB): Although its debt is 15 times greater than its cash, the company has ample real estate on its books at below market value, its shares are selling at a 20% discount to book, and it has been steadily improving same store sales. Management has plenty of skin in the game, with a 16% stake. The negative take; it's certainly a shame that management has not elected to enter into a share buyback program.

Farmer Brothers Co. (NASDAQ:FARM): This one fits the bill as the perfect value choice and is currently my largest single holding. Its turnaround efforts seem to be gaining traction, and the drop in coffee prices is just icing on the cake. The fact that the company's single largest shareholder and ESOP control 50% of the shares is proof that there is more than enough incentive in place to enhance shareholder value. The negative take; the company has not been too effective in communicating its turnaround efforts to the investment community.

Honorable Mentions:

Jet Blue Airways (NASDAQ:JBLU): Although the company has more debt than cash (about 2.5 times more), it is making money (selling at only 9 times 2012 estimates of .52) and its insiders are buying (outside director Peter Boneparth just bought a 50,000 share block). It is also selling at a 25% discount to book value. If jet fuel continues to drop in price, earnings could really take off. The negative take; the harmful stigma associated with airline industry continues to plague its shares.

Safeway Stores (NYSE:SWY): This one fails on the debt and book value tests, but comes up strong on its passion of returning cash back to its owners through its very generous dividend and aggressive stock buyback program. It recently increased its dividend 20% (it now yields a whopping 3.6%), and it improved its share buyback program by an additional $1 billion. At a forward PE of less than 10, the equity is undervalued. Wait! There's more; as an added bonus, we will throw in some takeover chatter to boot. The negative take; the company has not hired an investment banker to explore possibilities of selling itself.

Disclosure: I am long (SWY), (FSYS), (SWY), (FARM), (JBLU).