Six hot recovery plays

In 2000 a US accountancy professor, Joseph Piotroski, published a paper outlining a stock screen which had a record of delivering market beating returns by identifying genuine recovery plays. Back testing his screen, he found it had delivered an average annual return of 23 per cent over the two decades to 1996, which was double the performance of the S&P 500.

Our practical experience of the Piotroski screen is that it can pick corking recovery plays but can also come up with real stinkers. This is illustrated by the table below, which lists the performance of the stocks from the Piotroski screen we ran this time last year. Overall the screen substantially outperformed the FTSE All-Share index, delivering a total return (share price rise plus dividend) of 25.5 per cent compared with 14.9 per cent from the index.

*Shares suspended

Source: Datastream

The screen works by first selecting the quarter of stocks with the lowest price-to-book values on the market - this gives the screen a bias towards capital-intensive industries, and in the case of our whole-market screen, smaller companies which tend to command lower valuations. These stocks are then tested for nine indicators of solid and improving fundamentals based on their recent accounts. Stocks that pass eight or nine of the tests are deemed to have a high 'F-score', which makes them of interest. We provide write ups of the six highest-scoring stocks with market caps of over £10m below.

The Piotroski 'F-score' criteria:

■ Positive profit after tax, excluding exceptional items.

■ Positive cash from operations.

■ Profits after tax excluding exceptional items are up on last year, which Professor Piotroski highlights as being of particular importance as a signal that a company may be in recovery mode and in the process of re-rating.

■ Cash from operations higher than profit after tax, excluding exceptional items, which indicates an ability to convert accounting profit into actual cash.

■ Gearing (net debt as a percentage of net assets) is down on the preceding year, which suggests that the company has not had to look for external sources of finance.

■ The current ratio (current assets divided by current liabilities) is up on the preceding year, which suggests that the company's ability to service upcoming financial obligations is improving.

■ No new shares issued over the last year, which again suggests that the company has not had to look for external sources of finance.

■ Gross margins have risen in the last year.

■ Improving capital turn (turnover as a proportion of last year's net assets), which suggest greater productivity.

SIX HOT RECOVERY PLAYS:

Barratt Developments

Last year was fantastic for shares in housebuilders and the share price performance of Barratt Developments was particularly good. However, despite a 123 per cent share price gain in 2012, the stock still meets the Piotroski price-to-book-value criteria - although 91p or £892m of its net asset value is accounted for by intangible assets. The factors behind Barratt’s strong performance are common to its industry. Having worked through most of the problems created by the credit crunch, the company has been building homes on cheap land acquired at the bottom of the market at the same time as selling prices have been rising steadily. But Barratt has also benefited from the reversal of negative sentiment associated with high debt levels, relatively low levels of writedowns during the credit crunch and off-balance-sheet financing. The company has returned to profit and brokers forecast more to come.

Source: S&P CapitalIQ

Last IC view: Buy, 159p, 12 Sep 2012

Avocet Mining

Gold miner Avocet Mining had a torrid 2012 during which its operations were beset by problems. The key issue is that its Inata mine in Burkina Faso looks like it will be trickier to mine than originally thought with lower quality ore and higher production costs. All this has meant the group has had to delay its expansion plans and instead is concentrating on getting the most from its existing production. There are other exploration opportunities, but the bad news has severely dented sentiment and accounts for the low valuation against its assets, especially in relation to the peer group. While broker Numis hopes that expansion will happen by the end of 2015, it has nevertheless recently reduced its own NAV estimates from 113p to 70p.

Last IC view: Hold, 70.5p, 20 Jul 2012

Griffin Mining

Despite a very strong set of interim results in September, Griffin Mining’s shares had a disappointing 2012 and, in valuation terms, are in the dog house. Part of the problem has been sentiment towards zinc, the key metal mined by Griffin. The price has been falling as the steel industry, zinc's major consumer, has struggled. Sentiment has recently improved on the back of stronger economic data from China. But Griffin has also recently taken on significant debt after boosting its stake in its core joint venture. Production is also expected to be relatively flat over the next couple of years, which means there is limited room for excitement beyond that generated by the wider metal markets.

Last IC view: Hold, 32p, 4 Sep 2012

International Greetings

High debt levels and tough trading conditions in Europe and Australia have weighed on the shares of card and gift wrap company International Greetings. But the US market is proving more promising for the group and the company's debt levels are coming down. Broker Edison even has hopes that a dividend payment could be getting close. The company has also been investing in product innovation that should help it boost sales, especially of higher-margin products. A reorganisation of the group's manufacturing has also recently been completed, which will help reduce costs. So, there are some reasons to be hopeful, and priced at just over 7 times forecast EPS, the shares look cheap compared with larger state-side rivals - Edison calculates the discount to be nearly 20 per cent.

Last IC view: Good value, 64p, 6 Dec 2011

Augean

Hazardous-waste disposal group Augean is no stranger to the Piotroski screen. Its asset-focused business makes it a prime candidate for inclusion. The question is when this apparent value will be realised. Augean could be getting closer to finally fulfilling its promise, though, given a strategic move into new potential growth areas. It has won work disposing of low-level radioactive waste and is also moving in to the offshore waste-disposal market with its North Sea services business. That said, its traditional markets remain challenging and there is little certainty about how quickly growth from its new markets will come through. Using a disounted-cash-flow model broker Edison has a long-term, worst-case, fair-value price for the shares of 45.5p and a mid-case price of 75.6p.

Last IC view: Hold, 32p, 27 Mar 2012

Michelmersh Brick

The inclusion of Michelmersh Brick in our Piotroski picks serves as a reminder that this screen is very much focused on historic data. At the half-year stage Mickelmersh warned that profits would be well down in 2012 due to tough trading conditions, although, the company should at least break even. That said, the screen's focus on undervalued assets underscores a key attraction of the Michelmersh story. For some time the company has been trying to sell off land it owns in Telford to house builders. Progress is being made on a deal with Persimmon and planning consent is being sort on further brown-field land. The improved performance of house builders and a stronger market for sites should help underpin sentiment and increases the prospect of Michelmersh realising value from these assets. Meanwhile, the company offers longer-term cyclical upside should construction activity begin to pick up following recent signs that the market may have already hit its trough.

Last IC view: na