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Do Cheap Stocks Still Exist?

- By Jae Jun

I got a nice email the other day from an Old School Value Insider. He sent me the following email after I wrote about Gravity Co. and how it is now up 500% after I sold.

If I had to sum up the email in one short sentence, it is this.

I found Xunlei ( XNET ) and bought it at ~4.7 because its cash > stock price. I sold it at ~8, however it is 21 now.

Even by selling around $8, a 70% return in a couple of months is nothing to sneeze at and goes to show there are always pockets of value you can take advantage of before the market catches on.

Xunlei has come and gone, but how about we use the same idea and see what else is out there?

Step 1: Setting up the screen

Just like how the best way to catch fish is to use a fish finder to go directly where they are located, using a screener is the obvious tool of choice.

I didn"t ask what filters Chengmin used to find Xunlei, but here"s my screenshot of looking for cheap stocks.

Net Net Screener Filter - old school value screener

I have only two basic filters in the screen.

  1. Piotroski F-Score, TTM, between 5 and 9 because I want to limit my choices to cheap stocks with some OK fundamentals. The Piotroski F-Score does it all for me.
  2. Price to NCAV between 0 and 1. Anything inside this range will mean that the NCAV is greater than the market cap. It must be between 0 and 1. If NCAV is negative, it means there is a lot of debt, and if NCAV is greater than 1, it means it is not a net-net.

NCAV = Net Current Asset Value = Current Assets - Total Liabilities

By using NCAV, I"m not looking for strictly cash per se but an asset rich company with decent fundamentals.

Step 2: Setting up the report

Once the screen is set up, it"s easy to run and load the results. To make it easier when viewing and filtering the results further, I"m going to create a custom report.

I"ll call it "Net Net Report," and I"m adding the following to the custom report list:

My Custom Net Net Report - old school value screener

  • Market cap
  • Industry
  • Price to NCAV
  • Piotroski F-Score, TTM
  • Action Score Grade
  • Quality Score Grade
  • Value Score Grade
  • Growth Score Grade

This report will show the basics of what I need, a bird"s eye view of the fundamentals and what type of company I"m looking at.

China is Still Cheap and a Checklist to Follow

What I see is that many Chinese firms make the list.

If you don"t know my history with Chinese stocks, I lost a lot of money in 2011 in a Chinese company called China MediaExpress. This was an instance where a Chinese company becomes a U.S.-listed stock by buying an existing shell company. I still have a bad taste in my mouth when thinking about it.

Maybe it"s time to move on from that and see what is out there.

After all, you have the big powerhouses like Alibaba, JD.com and Tencent Holdings. Many of the smaller China scam companies have been taken down, and the ones that are active today do seem legit.

The ones I"ve highlighted below are cheap.

Cheap Net Net Stocks

  • CGA has a P/NVAC of 0.15
  • OSN has a P/NCAV of 0.19
  • BRON has a P/NCAV of 0.26
  • CURE has a P/NCAV of 0.28

The Piotroski F-Scores are not bad either.

I won"t go into these specific companies because at face value they look too good to be true.

But to look at net-nets a simple process is to stick to the following:

  1. In Circle of Competence - look at industries and businesses you understand.
  2. Has a Valid Operating Business - find out whether the business is real.
  3. Low Cash Burn - compare the cash balance each quarter and see how quickly it is going down.
  4. No Debt or Very Easily Manageable debt - check debt levels and compare to cash.
  5. No Insider Selling.
  6. Signs of Buybacks.

I"ve written about this before in this net-net analysis example and checklist.

Cheap stock results

Net net screener results - click to download

Using the six steps above, I"ve made available the list of stocks for you to go through on your own.

You can download the list of stocks using this link.

For the sake of this article, I"m taking it an extra step and filtering out OTC stocks.

This leaves me with the following results:

Results after more refining

As you can see, they are all small to micro caps. I yearn for the days when net-nets were bountiful.

Let"s check out a few cheap stocks.

Friedman Industries (FRD)

This is a perennially cheap stock. I"ve written about it previously too. It seems that whenever I make a bold claim, I"m wrong (message to self: read that lesson on being overconfident).

  • Why Friedman Industries Is My New Pick to Click

I first wrote about when it was $9.68 per share and the NCAV was $7.29.

I ended up selling at a loss as the economy became tougher on the company.

Today, it"s at $5.80. The market cap is $40.6 million and the NCAV is $43.9 million.

Since 2013, the margins have shrunk, profits have disappeared, growth has turned negative and cash balances are running low.

Using the checklist from above:

  1. In Circle of Competence - FAIL. It"s not a difficult industry, but its cyclical nature makes it difficult to be successful.
  2. Has a Valid Operating Business - PASS. Not a shell company.
  3. Low Cash Burn - FAIL. Cash burn has increased. Cash balance is also low. As it failed No. 3 on the checklist, there"s no reason to continue with it. But here"s what the cash burn looks like each quarter:

Old School Value financial statement analysis

4. No Debt or Very Easily Manageable - Skip it.

5. No Insider Selling - Skip it.

6. Signs of Buybacks - Skip it.

Richardson Electronics (RELL)

Here"s another company that brings back memories.

An important point about net-nets and other cheap stocks is that the majority fall back into the net-net range. Companies with bad business models or management may go up temporarily (a year or two), but they somehow manage to become cheap again.

What this means is that you should not expect net-nets to be a long-term hold in your portfolio. Once one reaches your sell price, whether it be NCAV or a certain price, sell and move on.

In the case for Richardson Electronics, its NCAV is $104.17 million and market cap is $82.62 million. This is a P/NCAV of 0.79. Put another way, a 20% discount to NCAV.

It"s important to check the quality of the assets. I don"t want to run into a stock like Friedman Industries where the assets decreased and lowered the NCAV and stock price.

  1. In Circle of Competence - PASS. I used to work in the RF and telecom industry. Richardson Electronics was a competitor. It"s not difficult to understand. Just as you don"t need to know the full specs and inner workings of an iPhone, you don"t need to know 100% about the products.
  2. Has a Valid Operating Business - PASS.
  3. Low Cash Burn - PASS. Cash burn has slowed down. It makes more sense to look at Richardson Electronics from an annual burn.
  4. No Debt or Very Easily Manageable Debt - PASS.
  5. No Insider Selling - PASS
  6. Signs of Buybacks - FAIL. This one is good to have. Not a must-have.

Richardson Electronics passes the mandatory items but is not a company I want to bet big on. It"s best to buy along with a basket of cheap stocks and distribute the allocation evenly among them to limit damage.

Download the Spreadsheet Results

You can download the list of stocks here.



This article first appeared on GuruFocus.