Sturm's Screens: Cinderella Stocks
By Paul Sturm
April 17, 2001
A fresh look at value stocks reveals how you can pluck winners out of the bargain bin.
THERE ARE nearly as many investment strategies as there are investors. But one of the simplest approaches works remarkably well. I'm talking about plain-vanilla bargain hunting based on the most straightforward yardstick of all: book value.
Ben Graham and his disciples knew this intuitively. And when economists started studying the stock market, they came to the same conclusion: Buy a diversified portfolio of low-book-value stocks, hold them for a year or so, and you'll beat the averages. Not always, of course. But often enough for long-term success.
This month I'm going to tell you about a remarkable new study that shows how to make this tried-and-true strategy dramatically more profitable. The results are among the most impressive I've seen in academic research.
The author is Joseph Piotroski, who teaches accounting at the University of Chicago business school. He's young, not a big name yet, and his specialty is nuts-and-bolts stuff such as financial-statement analysis. Piotroski is also practical, which is why he thought it might be possible to improve on the book-value effect documented by finance professors. Book value is simply assets minus liabilities.
Here, in a nutshell, is what he did. Piotroski tracked the performance of value stocks from 1976 to 1996. He zeroed in on companies in the bottom 20% of the price/book universe and found they beat the market on average by about six percentage points a year. That tracks with prior research, but what fascinated Piotroski is something that gets buried in other papers.
Value portfolios have both winners and losers. And Piotroski discovered that even though value stocks as a group do well, all the gains come from fewer than half of the individual companies. Would it be possible, he wondered, to separate the jewels from the junk?
Perfect Nines
These eight stocks meet all nine of Piotroski's criteria for profitability, capital structure and operating efficiency.
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