10 Stocks with Strong Balance Sheets and Improving Conditions

I admit I cannot predict the direction of the market.

However, what I can do to combat market risk and uncertainty is to search for quality companies.

To determine the quality of the business, a Professor by the name of Joseph Piotroski, devised a simple 9 point system by analyzing the balance sheet, which we know as the Piotroski score.

Introducing the Piotroski Score

The way the Piotroski score came about was when Piotroski noticed that in a basket of distressed stocks selling below book value, a few did very well. He then began a study to try to isolate whether a set of specific criteria could be replicated to produce the same effect for market beating performance. And he found just that.

What Piotroski found was that by looking at 9 aspects of the financial statements he could determine the balance sheet health as well as the improvement prospect of the investment. A  more detailed description by Piotroski himself can be read from the following link.

The 9 criteria can be split up into three groups, profitability, leverage & liquidity, and operating efficiency. For every criteria that is met, one point is given. The best score any stock can receive is 9.

Profitability

1. Positive return on assets in the current year (1 point)
2. Positive operating cash flow in the current year (1 point)
3. Higher return on assets (ROA) in the current period compared to the ROA in the previous year (1 point)
4. Cash flow from operations are greater than ROA (1 point)

Leverage, Liquidity and Source of Funds

5. Lower ratio of long term debt to in the current period compared value in the previous year (1 point)
6. Higher current ratio this year compared to the previous year (1 point)
7. No new shares were issued in the last year (1 point)

Operating Efficiency

8. A higher gross margin compared to the previous year (1 point)
9. A higher asset turnover ratio compared to the previous year (1 point)

10 Stocks that Piotroski would Choose

Running a query through the Old School Value Piotroski screen to find the companies that score a perfect 9 and then sorting them in order of lowest P/B, the following 10 stocks are produced.

The top 3 results consist of Echostar Corporation SATS, Northrop Grumman NOC and Quanex Building Products NX.

SATS and NOC both performed well in 2010 with NX just underperforming but still posting market averaging gains.

BestBuy BBY is also another interesting name in the list. With the 15% drop after reporting quarterly sales, Piotroski still sees the company to be healthy with plenty of improving conditions according to its 9 point rating system.

While you should not rely on the Piostroski score alone to decide whether to buy or sell a stock, it certainly filters out a lot of the bad investments.

My question for you is how well your stocks stand up to the Piotroski score. Go ahead and test the 9 criteria yourself to see how well your portfolio stacks up.

Jae Jun runs Old School Value, a value investing service providing free investing spreadsheets as well as premium intrinsic value calculators, stock analysis and value stock screens for the DIY investor. He writes a weekly Tuesday column for Benzinga.