Finding Winners in Last Year's Bargain Bin
Thursday, February 13, 2014
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

Investing’s Odd Couple
There are benefits to combining value with momentum.

The Benjamin Graham Approach
A look at this famous value investor’s approach (PDF).

AAII Discussion Boards
Value investors: What criteria do you use?

Most Popular AAII Articles

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  3. “Exploiting the Relative Outperformance of Small-Cap Stocks”



Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 40.1%, up 12.3 points
  Neutral: 32.5%, down 3.2 points
  Bearish: 27.3%, down 9.1 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »




One of the most-cited value investing studies says stocks with low price-to-book ratios outperform stocks with high price-to-book ratios. Investment firm GMO’s Ben Inker says the study’s findings still hold, but work better when a one-year lag is used.

In “The Cross-Section of Expected Stock Returns” (The Journal of Finance, June 1992), Eugene Fama and Kenneth French published data showing an inverse relationship between returns and valuations. Average monthly returns ranged from 0.30% for the decile composed of stocks with the highest price-to-book (P/B) ratios to 1.83% for the decile composed of the lowest P/B ratio stocks. Fama and French calculated average returns for the period of July 1963 through December 1990 for their study.

Inker updated the data and shared his findings in the February 2014 GMO Quarterly Letter. He concluded: “If we just look at traditional value for stock selection—good old price/book as enshrined by Fama and French—the cheapest 10% of the market has outperformed the broad market by 2.5% per year since 1965. Sounds fine, but since the original Fama/French paper was published in 1992, the group has actually underperformed by 1.6% per year. The same group lagged one year outperformed by 3.5% per year since 1965, and since 1992 has outperformed by 2% per year. You can see similar patterns in sectors as well. In most cases lagged value either works better than portfolios based on current data or works almost as well.”

What Inker is referring to is buying the stocks whose P/B ratios ranked in the bottom decile one year ago (stocks whose valuations were lower than 90% of all other stocks last year), instead of buying those stocks that now appear in the bottom decile. His rationale for doing so is based on momentum. A stock becomes very cheap because of selling pressure (downward momentum), and the selling pressure may continue for a while. By using lagged valuation data, an investor allows time for the downward momentum to end.

I created a basic stock screen based on Inker’s suggestion to see what would come up. Using the % Rank-Price/Book-1 year ago criterion in our Stock Investor Pro program, I identified the stocks whose P/B ratios ranked in the bottom 10% in February 2013. Then, to help eliminate those stocks that are cheap for a reason or are otherwise not attractive to me, I created a second screen filtering last year’s cheapest stocks. Specifically, I excluded any stocks that were not currently exchange-listed, are headquartered in China, have a share price below $4 or a market capitalization below $30 million, and were not profitable over the past 12 months.

Since I still had a pretty lengthy list (63 stocks), I decided to get a bit pickier. I required the stocks to have a 26-week relative strength rank of 60% or higher, a sign they have better-than-average price performance, and to be headquartered in the U.S. This narrowed the list to the 25 companies shown in Table 1 below.

Keep the simplicity of the screens used in mind when looking at the list. A closer analysis may reveal traits that make the stocks either more or less attractive investment candidates. [International Shipholding Corp. (ISH) and Willis Lease Finance Corp. (WLFC) are in our Model Shadow Stock Portfolio and I own them as well.]

Table 1. Momentum Stocks with Low Prior-Year Valuations
Company
Ticker
P/B
P/B 1-Yr Ago
26-wk Rel Str. Rank
American Independence Corp.
AMIC
0.83
0.42
83%
Bank of America Corp.
BAC
0.82
0.55
72%
Century Casinos, Inc.
CNTY
1.33
0.60
94%
CNO Financial Group Inc.
CNO
0.79
0.50
72%
Continental Materials Corp.
CUO
0.63
0.58
84%
E TRADE Financial Corp.
ETFC
1.20
0.62
86%
Equal Energy Ltd.
EQU
1.14
0.49
77%
Genworth Financial Inc
GNW
0.53
0.25
77%
Green Plains Renewable Energy
GPRE
1.32
0.59
84%
Hartford Financial Services
HIG
0.82
0.46
64%
HMN Financial, Inc.
HMNF
1.03
0.61
88%
International Shipholding Corp.
ISH
0.57
0.50
64%
Jefferson Bancshares Inc.
JFBI
0.91
0.61
85%
The L.S. Starrett Company
SCX
0.89
0.59
90%
Lincoln National Corp.
LNC
0.97
0.54
69%
Monster Worldwide, Inc.
MWW
0.95
0.61
91%
Oppenheimer Holdings Inc.
OPY
0.64
0.51
78%
Parke Bancorp, Inc.
PKBK
0.99
0.60
84%
Protective Life Corp.
PL
1.06
0.56
67%
SigmaTron International
SGMA
0.68
0.44
96%
Spirit Realty Capital Inc.
SRC
1.11
0.48
73%
Summit Financial Group, Inc.
SMMF
0.67
0.52
66%
Sussex Bancorp
SBBX
0.76
0.55
83%
WashingtonFirst Bankshares Inc.
WFBI
1.02
0.51
75%
Willis Lease Finance Corp.
WLFC
0.70
0.62
77%


More on AAII.com

The Week Ahead

The U.S. financial markets will be closed on Monday in observance of President’s Day. Our office will be closed as well.

Slightly more than 40 members of the S&P 500 index are scheduled to report earnings. Included in this group are Dow components Coca-Cola Co. (KO), reporting on Tuesday, and Wal-Mart Stores (WMT), reporting on Thursday.

The February Empire State manufacturing survey and the February National Association of Home Builders housing market index will be the first economic reports of note, with a Tuesday release date. Wednesday will feature January housing starts and building permits, the January Producer Price Index (PPI), and the minutes from the January Federal Open Market Committee meeting. The January Consumer Price Index (CPI) and the February Philadelphia Fed manufacturing survey will be released on Thursday. Friday will feature January existing home sales.

Two Federal Reserve officials will speak publicly. St. Louis president James Bullard will speak on Wednesday and Friday. San Francisco president John Williams will speak on Wednesday.

The Treasury Department will auction $9 billion of 30-year inflation-protected securities (TIPS) on Thursday.

February stock options will expire on Friday.

Gentlemen, a friendly reminder that tomorrow is Valentine’s Day.

AAII Sentiment Survey

Bullish sentiment rebounded strongly in the latest AAII Sentiment Survey. The 12.3 percentage point rise was the largest since a 12.9 percentage point rebound on November 28, 2013. Accompanying the increase in optimism was the largest weekly drop in pessimism since August 29, 2013.

Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 12.3 percentage points to 40.1%. This is a five-week high. The historical average is 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, declined 3.2 percentage points to 32.5%. This is a five-week low. Even with the decline, neutral sentiment remains above its historical average of 30.5% for the sixth consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 9.1 percentage points to 27.3%. The drop reverses two consecutive weeks with readings above 30% and puts pessimism below its historical average for the 19th time in the past 23 weeks.

Though the proportion of bulls increased significantly in this week’s survey, it’s worth noting that optimism remains below the levels registered at the start of this year. Furthermore, the current six-week streak of consecutive above-average neutral sentiment readings is the longest since last summer’s 12-week streak (May 30 through August 15, 2013).

The rebound in the S&P 500 after its recent pullback has likely alleviated concerns, at least temporarily, among individual investors about whether the market established a short-term top at the start of the year and whether a correction is looming. Sustained earnings and economic growth, Federal Reserve Chairman Janet Yellen’s intent to continue tapering bond purchases and the debt ceiling agreement are also contributing to the optimistic six-month outlook. Keeping some individual investors bearish are worries that the market’s weakness is not over, elevated stock valuations, the pace of revenue growth and Washington politics.

This week’s special question asked AAII members how fourth-quarter earnings have impacted their six-month outlook for stock prices. Approximately 46% of respondents said the recent earnings reports did not alter their short-term outlook. Several said this was because earnings largely met their expectations, while some others said other factors are having a bigger influence on their outlook. About 11% said they are more bearish because of earnings and an additional 9% said they have tempered their outlook after looking at the profit figures. Some of these respondents cited disappointing reports or a lack of revenue growth. A small group, 6% of respondents, said earnings season has made them more bullish.

Here is a sampling of the responses:

  • “Recent earnings are generally as expected.”
  • “They have not. Other factors took precedent”
  • “Yes. Many companies I follow had slightly improved earnings”
  • “They have added to other news that together has reduced my outlook from positive to neutral.”
  • “Earnings disappointments and expectations for lower earnings have caused me to pull back my exposure to the stock market”

» Take the AAII Sentiment Survey