RealMoney Silver - Use Your Tools to Find Good Value

Use Your Tools to Find Good Value
By Tim Melvin
RealMoney.com Contributor
2/22/2008 2:44 PM EST

In yesterday's column, I talked about the need to credit score your stocks and introduced the two tools I prefer to use to do this. I have found that the Altman Z-Score and Piotroski scale help me avoid the distressed stocks that are truly distressed and unlikely to recover. I sat down with my laptop and calculator this morning and started searching for some stocks that passed muster on both scales and sold for less than book value. The idea is to find value stocks with rock solid balance sheets as well as decent prospects for recovery.

I looked for stocks that had at least 5 out of 9 on the Piotroski scale and a Z-Score of 3. The stocks mentioned here are far from a complete list, but they're an example of the types of bargains that can be found by screening for cheap stocks and then checking their credit scores.

My first stock uncovered is Integrated Device Technologies (IDTI) . IDTI has a healthy Z-Score of 5.7 and a Piotroski score of 5. The company is in the semiconductor business and has sold off sharply over the past year. It is off about 50% from its highs and at less than 90% of book value. The balance sheet is strong with about 20% of the share price in cash and no debt.

The company's core business lines -- server memory and PC clocks -- have been weak lately, and the stock sells near a five-year low. In its last earnings report, the company lowered its expectation for the next quarter. The company is well positioned to survive the downturn and should do extremely well when the semiconductor business bottoms and begins to turn up, hopefully later this year.

The company is buying back stock in the open market and still has $130 million of stock to buy under its current authorized buyback plan. I like this stock for an economic recovery and have added it to my list of stocks to watch. The options are way too cheap to sell puts, but if you think the semiconductor stocks will rally this year, the 2009 January calls are a good bet.

The next stock is an old favorite, one I have owned off and on several times over the years. Helen of Troy (HELE) has a solid Z-Score of 4.6 and a P-Scale rating of 6 out of 9. The company makes personal care items such as hair dryers and curlers as well as kitchen items.

The stock sells at 75% of book value and just 7 times earnings. The company has a good balance sheet with over $100 million in cash. Management is cutting lower-margin product lines; making drastic reductions in selling, general and administrative (SG&A) costs; and paying down debt. The retail environment will continue to be difficult, but the company is optimistic that it can grow sales modestly and boost margins going forward and continue to generate cash in 2008.

I like this stock and I respect management. I wish I had run these screens on Monday, as the stock is up today. The May options are thinly traded, but if you can split the wide bid-ask spread, selling the May 15 puts should be rewarding; if the stock slips back toward $15, I would be an outright buyer of the shares.

It's no surprise that a retail clothing company made the list given the steep selloff in the sector. Jones Apparel (JNY) made the cut with a Z-Score of 3.34 and a P-Scale reading of 7. The company sells brand-name clothing through its own stores as well as department stress and other retail outlets. The company has some of the premier women's clothing brands including Anne Klein, Nine West, and its own Jones of New York.

The stock is down about 60% from the highs and sells at 60% of book value. The company is restructuring to get rid of some lines -- it recently divested the unprofitable Barney New York stores -- and is buying back stock. The balance sheet is solid, with over $300 million in cash at the end of the quarter. I do not think retail apparel business will get better soon -- apparently company insiders agree, as there has been some selling of late -- but this is one to keep an eye on when the economy turns up and the consumer starts shopping again.

More aggressive investors with a better outlook for retail might want to look at the January 2009 combination trade. You can buy the stock here and sell the 17.50 calls and 12.50 puts for a combined premium of 3.10, a healthy 20%. Of course, should things get worse, you will have to buy stock below $12.50.

There are several more beaten and battered stocks that make the cut, but space doesn't really allow me to go through them all. I used these to give you an idea of the type of bargain stocks you can find and how I might trade them in this market. Although it is a little more work than buying the new-high list and praying for momentum, academic research and real-world experience show that this method pays off for patient investors with returns that solidly beat the market.