9 value stocks for impatient investors

By Harry Domash

Judging from my mail, most of you are, like me, growth investors. We like companies with new products that sell fast and boost profits.

But fast growth typically doesn't happen without a few stumbles. When sales slow, even briefly, or when earnings fall a bit short of analysts' forecasts, some growth investors are quick to pull the trigger on a stock sale.

That's when value investors enter the picture. Knowing that the market often overreacts to bad news, they look for stocks with fixable short-term problems that will return to favor once they get back on the growth track.

Unfortunately, many investors, including me, don't have the patience needed for traditional value investing. With that in mind, I've devised a screen for impatient value investors. It uses a value formula to define a universe of worthwhile candidates and relies on technical (charting) factors to pinpoint stocks that have already started moving up.

Down but not out

My value-stock selection strategy is based on a formula devised by University of Chicago professor Joseph Piotroski.

Before Piotroski, value strategies involved buying large portfolios of cheap stocks, typically based on valuation ratios such as price-to-book (share price divided by shareholders equity). But Piotroski figured that many stocks in that category are doomed to fail, either because they don't have the right products or because they lack the financial strength needed to overcome their problems.

So he devised a simple formula for pinpointing likely survivors. These are already profitable firms with strengthening financial statements and improving profit margins.

I described a screen for picking stocks following Piotroski's rules in summer 2005. By the end of 2006, eight of the 11 stocks in my portfolio had recorded gains, but, on average, the portfolio was only up 12%, better than the Nasdaq Composite Index's ($COMPX) 10% return over the same period but short of the S&P 500's ($INX ) 15% gain. Theoretically, the results will be more impressive in another year.

However, last spring, my patience ran out. I wanted to see faster results. I decided to stick with Piotroski's selection formula but focus on stocks that had already started moving up.

Chart readers compare a stock's current price to its moving average (which is the average of a stock's closing prices over a defined number of days) to determine whether it's in an uptrend or downtrend. Stocks trading above their moving averages are in uptrends, and those below in downtrends. Stocks are usually compared to their 200-day moving averages for a long-term perspective and to their 50-day moving averages for a shorter view.

I required that my value picks must meet my interpretation of Piotroski's requirements but must also be trading above their 50- and 200-day moving averages.

So far, the results have been encouraging. For instance, on May 8, 2006, my screen came up with a five-stock portfolio that, as of Dec. 29, was up 24% versus 3% for the Nasdaq and 7% for the S&P 500. Equally encouraging, four of the five picks were in positive territory.

Here's how it works, starting with my version of Piotroski's formula:

First, find the cheap

The price-to-book ratio is usually the valuation ratio of choice to divide stocks into value and growth categories. The last time I checked, the median PB ratio of all U.S. stocks was around 1.7. Researchers usually use the median as the boundary between value and growth. I set my maximum allowable PB at 1.5 to insure that they were well within the value definition. Try moving the limit to 1.7 if you want to see more stocks.

Screening parameter: Price/Book Value <=1.5

Profits and cash

Piotroski wants profitable companies, both in terms of reported income and cash flow (actual cash that flowed into or out of the firm's bank accounts).

I require a positive value for net income from continuous operations, which excludes income from units that were sold or closed during the year.

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