Under the Radar: Uncovering Profitable, Undervalued Stocks

I am a bit of a geek and a nerd.

I freely admit it.

I read academic research like spy novels.

I spend hours testing ideas to validate or destroy approaches to markets that appear to have merit.

Very few ideas or theories stand the test of scrutiny. Fewer still withstand the test of popularity and time.

Tens of thousands of research papers have been written, reviewed, and even touted over the past forty years or so.

A small handful have survived and proven helpful in the effort to earn market-beating returns.

One of the most valuable and profitable papers written during my career came from Professor Robert Novy-Marx, a professor at the University of Rochester’s Simon Business School. I was reminded of this paper when I sat down last week to read Dan Rasmussen of Verdad Capital’s new book “The Humble Investor.”

I highly recommend the book, by the way. It earns my highest praise: the label as a book that will make you money.

Novy- Marx's groundbreaking 2013 paper, “The Other Side of Value: The Gross Profitability Premium,” published in the Journal of Financial Economics, changed my view, and many others’, of finding and investing in great companies.

The core of Novy-Marx’s discovery lies in what he termed the “gross profitability premium.” His research demonstrated that profitable firms generate significantly higher returns than unprofitable firms.

While that sounds like common sense, look at the profitability of all the story, hopes, and dreams stocks floated around today, and you are likely to find low or non-existent profitability.

He also found that investing in profitable companies performs as well as investing in cheap stocks. Novy-Marx defines profitability differently than most. He uses gross profitability, not line earnings or cash flow. He looks at revenues minus the cost of goods sold.

Everything that happens after that is subject to gimmicks, tricks, smoke, and mirrors to make the bottom line look good.

Novy-Marx also found that companies with high profitability tend to stay profitable for an extended period, making them perfect for patient, aggressive investors. Focusing on gross profitability works very well.

It has worked in the past.

It will work in the future.

You rarely hear it discussed.

It is almost entirely off the radar screen of the EPS and story-focused investors and traders who are the most active in today’s markets. This makes it a perfect candidate for consideration in our search for market-beating and wealth-building strategies.

Large-cap tech companies like Apple AAPL, Amazon AMZN, NVIDIA NVDA, and Meta META are all on the high profitability list.

Every firm on Wall Street also follows them; everyone on the planet has an opinion on the shares, and we can gain no advantage.

However, several highly profitable companies are either ignored by Wall Street or outright hated by most investors.

Lincoln Education falls into the hated category. Whenever I mention a for-profit education company, the reaction is between disgust and disdain. I get it. Several scandals over the years have involved enrollments, student loan programs, and outright fraud.

That was then. This is now.

Lincoln Education started after World War II in Newark, New Jersey, as a technical institute providing training for returning GIs. It seems that there was not much demand for tank drivers and artillery loaders stateside.

There was demand for mechanics and other skilled trades, and those are the skills Lincoln Technical Institute provided.

They still teach those skills along with medical and Information Technology trades. We have discovered that we do not need that many 18th Century English Literature and Art History majors. We do need auto mechanics, plumbers, electricians, HVAC technicians, and medical assistants.

Lots of them.

Lincoln has expanded and now has 22 campuses in 13 states with approximately 15,900 students.

90% of the students who graduate from Lincoln Education programs have skills considered essential by the government.

Lincoln’s education stock may be hated, but this is an excellent business with high-profit margins and no debt. The stock keeps moving higher despite investors’ distrust and has strong momentum.

Charlie Munger was a big fan of buying great businesses at reasonable prices. Lincoln Education is a great business.

So is OneSpan OSPN.

OneSpan (OSPN) is a cybersecurity company that helps businesses and banks protect online transactions and prevent fraud. It provides tools to ensure that only the right people can access sensitive information or complete financial transactions. Banks, government agencies, and businesses worldwide use OneSpan’s technology to protect their customers’ accounts.

Sixty of the world’s largest 100 banks are OneSpan customers. So are several government agencies, including NASA and the US Post Office. The company has over 4,000 customers in 100 countries around the world.

OneSpan has a fortress balance sheet, fat margins, and a reasonable valuation at the current price.

Profitability drives performance. Adding gross profits as a percentage of assets to your investing toolbox can help boost your overall returns and get you closer to your financial goals.