US Piotroski plays deliver

This time last year, though, with signs of a US economic recovery in sight, we ventured across the pond to run a famous screen devised by an American accountancy professor, Joseph Piotroski, on its home turf. The 12 stocks picked by the screen have performed incredibly well, generating a total return of 62 per cent compared with 25 per cent for the Russell 3000, from which the shares were picked (see table). It's also very gratifying to note that the four shares we wrote up as particularly good cyclical plays (Gray Television, Office Depot, Kimball International and Luby's) delivered an average return of 114 per cent, largely assisted by Gray's phenomenal run.

Source: Thomson Datastream

The consensus view now seems to be that there is more to come from the US economy which means the grounds for rerunning Mr Piotroski's screen are good. The screen looks for out-of-favour stocks and then looks at nine measures based on historic fundamentals to assess the likelihood that the underlying business is in recovery mode. If the business is recovering, then, the theory goes, the price of its shares should soon follow. Mr Piotroski found his screen produced annual returns of 23 per cent over the two decades to 1996, which was double the performance of the S&P 500.

Out-of-favour stocks are identified by looking at price-to-book value (PBV). Specifically, the screen is interested in the quarter of stocks with the lowest PBV on the market. The stocks then receive a so-called F-score from zero to nine based on the nine criteria listed below. Any low PBV stock with a score of eight or nine is of interest. We list the stocks that passed below and have written up five of the passing shares to give a flavour of what is on offer. Unlike last year, when the shares we wrote up were selected for their merits as cyclical plays, this year we've just tried to pick a diverse selection of five shares from a list of 16 that is dominated by financials.

Genworth Financial

Shares in mortgage insurance and life insurance company Genworth boast the best three-month momentum out of all the stocks that passed our Piotroski screen. It's not hard to see why the market is getting excited. The company's mortgage insurance operation stands to benefit from the recovery in the US housing market as improved conditions should reduce defaults on loan payments, thereby increasing the business's margins. What's more, the quality of the business is improving as new higher-quality policies begin to make up a greater proportion of the whole. The company is also seeking to deal with investors' concerns about liquidity by floating its Australian mortgage insurance business and selling its wealth management business. The life insurance side of the business looks less inspiring, but nevertheless there are a number of reasons for optimism. The market has recently warmed to the sector due to its historically low levels of return on equity, which suggest there could be major upside if a sustained recovery kicks in.

Source: S&P Capital IQ

Brandywine Realty

As an office real estate investment trust (Reit), Brandywine Realty can certainly be considered a cyclical play. But the company has been left behind peers during the recovery in the sector. The nature of the offices Brandywine invests in is the key reason for the discount to rivals - broker JPMorgan estimates that, stripping out debt, its enterprise value/cash profit ratio of 13 times represents a 26 per cent discount to the peer group average. Brandywine's portfolio is made up of suburban offices that are likely to lag the recovery of the office market in major cities. Indeed, the recovery in the US office market in general has been patchy so far. That said, occupancy growth is forecast for the coming years. The Reit has also been trying to boost returns with investments in the residential market, which is showing good signs of recovery. The company raise $185m last month with a placing of new shares, and the rise in shares outstanding is the one Piotroski test it fails. It's not yet clear what the money will be spent on but it looks useful to have in the war chest.

CentryLink

Shares in telecoms group CentryLink lost almost a quarter of their value in February when the US dividend darling announced it would be cutting its yearly payout by 26 per cent. That means the yield investors should expect from the shares is about 5.8 per cent rather than the historic yield published in our table. Rather confusingly, along with the cash-conserving cut, the company also announced a $2bn share buy-back programme. The buy-backs should help enhance EPS during a tough time for the group's margins while the stated aim of the cut - to reduce the group's substantial debt - will also help the bottom line by cutting into the substantial interest bill. Meanwhile, the group is investing heavily in growth areas, such as data centres and video, to head off the decline in its traditional and higher-margin voice-call business. Broker JPMorgan Cazenove believes management's efforts to reinvent the business should see its falling revenues stabilise next year and cash profits should bottom out not long after. The broker is forecasting EPS growth though for the foreseeable future, with a marginal rise this year, followed by nearly 5 per cent next year.

Carnival Corporation

As far as UK investors are concerned, cruise ship giant Carnival has the advantage of having a dual-listing on the London Stock Exchange. The big disadvantage with its shares, though, is that the company has suffered a litany of woes recently, many of which have involved high-profile problems with its ships - the Costa Concordia disaster being the most tragic and widely reported. The company has now announced a $600m investment in ship improvements which may go some way to countering fears but will also dampen expectations of an immanent cash return due to previously reduced capital expenditure plans. The company also has significant exposure to Europe and is suffering from the impact of the economic slowdown in the region. But there are some grounds for optimism about future prospects beyond hopes for an economic pick up. Cruise ship capacity is forecast to fall, which should allow Carnival to boost the yields it gets from its berths. This is definitely not showing through yet, but in March the company downgraded yield-growth guidance from 0-2 per cent to "broadly flat". Still, the recent fall in the oil price should help as this is a major component of the company's costs.

Rowan Companies

Rowan is a leading player in the 'jackup' oil and gas drilling rig market. These are floating rigs that are dragged to drilling locations before being 'jacked up' ready for operation. The company has a well invested fleet of 31 rigs, many of which are able to command premium rates. While rates are expected to increase this year, there are currently about 50 new rigs being built which could well put a dampner on the growth rate in coming years despite the fact that over 60 per cent of the 290-stong global fleet are over 25 years old and considered past it by industry standards. But the group is also moving into the ultra-deepwater market and has four ships under construction at the moment. This is considered a more desirable part of the market and the rating on Rowan's shares has been expanding as a consequence. Positive news on contracts for ships that are yet to be rented out could provide a share price boost.

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