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Value Play: CA, Inc. (CA)

by
January 12, 2011 1:27 am
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In the search for cheap stocks, the number one problem plaguing value investors is weeding out unstable or even fraudulent companies — in other words, stocks that have a reason for being cheap. As a result, measures like P/E, P/B, etc. are only instructive so far as they’re combined with a search for financial strength and improvement.

CA, Inc. (NYSE: CA) is one stock that stands out in any such search. It’s P/E ratio excluding extraordinary items (my preferred valuation, since it excludes the impact of one-time events on the firm’s earnings) is rock bottom – 15.87 vs. an industry median of 23.94. It’s trading at only 2.34 times book value (5.29 P/B industry median) and 2.83 times sales (5.17 P/S industry median). The software and programming company is clearly undervalued by traditional measures.

But we must recall that stocks are cheap for reason. When I first started following the market, I looked at these measures alone and got burned on Chinese companies hit by scandals like Fuqi International (NASDAQ: FUQI) and China Sky One Medical Inc. (NASDAQ: CSKI). It’s easy to be enticed by low P/E’s and overlook troubling numbers like poor cash flow, debt, etc.

That’s where a Piotroski screen variant comes in handy (to learn more about Piotroski screens, see Benzinga Brain Trust columnist Jae Jun’s recent column here). I use the following Piotroski hybrid to make sure I’m only investing in solid, improving companies.

1) EPS (excluding extraordinary items, TTM) is positive.
2) Business income (operating profit adjusted for unusuals) is positive.
3) Operating cash flow per share is positive and above EPS.
4) Operating margin has improved in the past year.
5) Total debt to assets ratio has improved in the past year.
6) Return on assets has improved in the past year.
7) No increase in shares outstanding in the past year.
8) Return on equity improved in the past year.
9) Recent insider buying activity
10) Accrual ratio less than 1 over past 12 months

CA Inc. was one stock that passed with flying colors. Moreover, with earnings coming up January 24th, a long position here could pay off big if the company reports decent results. However, if the stock pops significantly before as other investors see its valuation and pile in, I’ll be closing out this position to avoid a potential bubble before that date.

Other stocks that showed up in this screen were Cardinal Health Inc. (NYSE: CAH), Devon Energy Corporation (NYSE: DVN) and NYSE Euronext (NYSE: NYX).


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