Value Opportunities: Screen for low valuation and high potential

The Capital Cube Screener is almost endlessly customizable and lets investors create unique combinations of factors to find inviting opportunities. We will examine a couple of metrics that, when used concurrently, show a great disparity between current price level and the market's expectations. The two operative measures used in this article to find companies with a low valuation and high potential are Valuation Characteristics and Relative Valuation . Valuation Characteristics categorizes each company by evaluating its Return on Equity versus its Price to Earnings ratio. The Turnaround selection under this heading screens for companies that have lower than average ROE but boast a high PE ratio. The rationale holds that a stock with a higher than average PE ratio is expected by the market to vastly improve its performance, and companies with low ROE have the most to gain when conditions improve. For an increased understanding of the different interpretations of ROE, check out this article .

Relative Valuation also plays an integral role in locating candidates poised for a turnaround in value, as it is an important measure of investor sentiment. Using the Price to Book value of a company in the context of its peer group can help identify stocks that trade at a discount to what they are worth. The significance lies heavily in the idea that companies poised for a turnaround have the largest room for improvement when they already trade below the median PB of their peer group. Another way to ensure benefiting as much as possible from a turnaround is to select a company that currently trades in the low quartile of its 52-week range. This narrows the field to companies that are undervalued historically as well as fundamentally. Also helpful is omitting extraneous movers by centering one-month price performance a few percentage points above and below the overall market's performance through that time period.

Below is a great screen for setting up value-turnaround candidates:

FirstEnergy Corp. (NYSE:FE )

FirstEnergy Corp. is one of the best candidates that results from screening with this method. For starters, the company's ROE has been particularly inefficient at 0.7% compared to the peer group median of 8.6%. The low amount of net income compared to equity has driven the stock to the lower 7% of its 52-week range. However, the market is clearly pricing in a reversal of performance, with investors paying an astounding multiple of 124.5 times earnings. As PE is almost entirely relative, it is important to view the astronomical figure against the 20.37 median of FirstEnergy's direct peer group. Compounding the effect of the anticipated performance upturn is the discount at which the stock is currently trading to its book value. The firm's Price to Book ratio is only 1.0, representing a relative undervaluation to the sector's 1.4 median. The below image exemplifies the recent advancements that are being incorporated into the company's share price, and it shows the widening gap between investors' willingness to pay a steep multiple of earnings and the current fundamental valuation.

Asta Funding, Inc. (NASDAQ:ASFI )

Asta Funding, Inc. also makes the list for companies that fit the Valuation Characteristics and Relative Valuations mold quite nicely. Being characterized in the Turnaround category means that the market is displaying expectations for the company to outpace its peers' earnings growth and increase in ROE. Having sunk to a relatively low operating advantage of 1.6% vs. the 12.2% average of its peer group, Asta Funding has also fallen into the lower quartile of its 52-week trading range. But the extraordinarily high multiple on earnings that investors are willing to pay shows that the market is pricing in greater earnings growth than the rest of the sector. The 39.3 PE ratio of the company more than quadruples the mid-line of 9.2 across its competitive landscape. Asta Funding is particularly poised to benefit from such a turnaround, as it trades at a Price to Book ratio around half that of its direct peers. A PB ratio of 0.6 shows that the firm is likely undervalued compared to expectations of a turnaround in ROE and also compared to the sector that boasts a very even 1.1. Notice, again, that this stock trades at a heavy discount to book value but claims a growing multiple on earnings.

It always helps to break down any particular setup to its basic elements. When looking for possible turnarounds or value candidates, a high relative PE shows that a company with lower than average Return on Equity is expected by the market to experience a sharp increase in performance. Also, a stock that meets these conditions, while also trading at a steep discount to book value, has the most to gain from an upturn in its ability to create earnings against equity.

The views and opinions expressed above are those of the author and do not necessarily reflect the views of  CapitalCube .com, AnalytixInsight, Inc. its affiliates, or its employees.