Rebound Stock-Picking With Book Value

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers. To subscribe to RealMoney, click here.

As the market plunged to new depths last November, it proved to be a great time to run screens to see which stocks were oversold in relation to their balance sheets and income statements. Many of the most deeply discounted names from that period had the most aggressive snapbacks when the market rallied into the new year. With the market in another tough phase in the first two months of 2009, it's time to revisit that approach.

One of the greatest tests of support for a stock is a company's tangible book value. For this screen, I went looking for stocks that now trade for no more than 1.2 times tangible book value. Can a stock fall below tangible book? Sure, but in time, they tend to rebound to at least the 1.0-1.2 times book value level.

Of course, book value will erode if a company is losing value, so I narrowed the list to only those companies that are expected to stay profitable in 2009. In theory, further profits should boost book value even higher. I also wanted to be sure that these stocks were liquid enough to garner strong institutional support when the market turns.

Right now, many hedge funds are going out of business, and second-tier research departments are shrinking, and these two groups have often been the pillars of support for less liquid stocks. So this list includes only stocks that trade at least 1.5 million shares per day.

As a final screening variable, I looked for companies with at least $150 million in net cash, so any upcoming debt payments can be handled without stress.


Trading Near Tangible Book Value
Company
Ticker
avg. daily volume (K)
Net Cash & Equiv.
Market Cap. (US$)
Tangible Book Value
Tang. Price Book
2009 EPS
"normal" EPS
2009 P/E
"normal" P/E
Foot Locker, Inc.
FL
3,066
272
1,134
1,771
0.6
$0.59
$1.61
12.7
4.6
Tellabs, Inc.
TLAB
5,404
376
1,492
2,118
0.7
$0.15
$0.44
25.2
8.6
Ensco International
ESV
3,683
256
3,564
4,044
0.9
$7.17
$6.66
3.5
3.8
Molex
MOLX
1,526
156
2,127
2,303
0.9
$0.46
$1.19
26.4
10.2
IAC/ InterActiveCorp
IACI
2,122
1,895
2,113
2,130
1.0
$0.63
$1.80
23.8
8.3
Abercrombie & Fitch
ANF
4,097
560
1,969
1,801
1.1
$1.84
$3.38
12.3
6.7
JDS Uniphase
JDSU
5,132
297
638
558
1.1
$0.21
$0.50
13.3
5.6
Corning
GLW
16,546
4,267
15,186
13,138
1.2
$0.63
$3.37
15.3
2.9
Sources: First call, Thomson Reuters, company reports

With the list in shape, I thought it would be helpful to see how these stocks trade in relation to their "normal" earnings strength. That means looking back to 2007, when earnings and margins were more in line with historical norms. Will we ever return to "normal?" Yes. A wide range of industries are purely cyclical, and their peaks and valleys look fairly predictable over a longer time horizon.

But stock selection remains vital, as the pair of retailers on the list tells us. Right now, people may hold off buying new footwear, and that is crimping sales for Foot Locker ( FL). But shoes and sneakers wear out. They are not luxuries but necessities. So in time, sales and profits for Foot Locker should rebound. In advance of an eventual rebound, shares trade for just 0.6 times tangible book value and less than five times "normal" earnings.

More Stock-Picking Training

  • Focus on Assets Over Earnings
  • Top Four Net/Net Plays
  • Prep for the Market Turnaround Now
  • Dig into the Details
  • Value Stock-Picking With Book Value
  • Yet, it's hard to be equally sanguine on the prospects of the retailer Abercrombie & Fitch ( ANF), which is much more beholden to the fickle tastes of teens. The retailer has held up fairly well in this downturn, and analysts believe EPS could still approach $2 this year, but the stock shouldn't be viewed as purely cyclical.

    Other stocks on this list can't be viewed through the context of cyclical earnings and instead are pure "balance sheet plays." IAC/InterActiveCorp ( IACI) trades pretty much for its cash holdings and is not given much credit for the value of its holdings, such as Ask.com, Citysearch.com, Match.com, CollegeHumor.com and the Daily Beast (which is quickly gaining traction as a rival to the Huffington Post).

    Ideally, you can find a stock with a defensive valuation (at or near book value) that is cash-rich and poised for significant upside when the market improves. That would appear to be the case for Ensco International ( ESV), an oil driller that will likely have little good news to report when earnings hit the wire this Thursday, Feb. 26.

    This is a lousy time for the energy sector, with prices low and drilling activity falling fast. But Ensco is still expected to stay nicely profitable through this downturn. Analysts say the company can earn more than $7 a share this year, but you should assume that the forecast may be too aggressive. Management may well dampen the profit outlook later this week, and that could push shares below the 52-week low. But even if per-share profits only end up at around $3 to $4, then shares sport a reasonable 6 to 8 times earnings multiple on that lowered forecast.

    Energy watchers say that later this year, the sharp production cuts will set the stage for rising energy prices. And that should set the stage for the next cycle of rising drilling activity. And in that phase, Ensco looks positioned to again generate $6 to $8 a share in profits, which looks pretty good for a stock trading in the mid-$20s. And for a stock already trading below tangible book value, it seems unlikely that any near-term pressure on the stock due to the imminent earnings release will be short-lived, because of that balance sheet strength.

    This was originally published on RealMoney on Feb. 24, 2009. For more information about subscribing to RealMoney, please click here.

    David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.

    More from Investing

    UK Prime Minister May to Fight Leadership Challenge 'With Everything I Have Got'

    UK Prime Minister May to Fight Leadership Challenge 'With Everything I Have Got'

    Facebook's Search Test Is a Reminder of its Untapped Revenue Potential

    Facebook's Search Test Is a Reminder of its Untapped Revenue Potential

    It Was a Confusing and Chaotic Day

    It Was a Confusing and Chaotic Day

    Chart of the Day: McDonald's Management Maneuvers Amid Taxes, Tariffs

    Chart of the Day: McDonald's Management Maneuvers Amid Taxes, Tariffs

    Market Madness: This Market Is for Stock Pickers

    Market Madness: This Market Is for Stock Pickers