Recently, the S&P 500 index hit a new all-time high over seven consecutive trading days. The large-cap index, along with the Nasdaq composite and the Dow Jones industrial average, closed Friday, July 9 within 1% of their respective all-time high.
With the U.S. stock markets rebounding strongly from last year’s coronavirus-induced slump, many investors, especially those who prefer value-oriented stocks, are finding that the cupboards are becoming a bit bare.
That doesn’t mean that there aren’t value opportunities out there. They are just a little harder to find.
For value investors, the sweet spot in investing is being able to buy an undervalued stock right before its value is recognized by the market and just before its stock price begins to take off.
But how can a value investor tell when a stock is in the sweet spot? The answer, according to Brian Nelson—president of investment research company Valuentum Securities—is to identify stocks with good value that are just starting to exhibit good technical/momentum characteristics.
Doing so helps an investor to avoid:
Several research studies—most notably a study done by Cliff Asness of AQR Capital, Tobias Moskowitz of the University of Chicago and Lasse H. Pedersen at the New York University in their paper “Value and Momentum Everywhere”—make the argument that value and momentum strategies work well together. In their research, Asness et al. show that over time combining value and momentum strategies across diverse markets and asset classes results in significantly higher risk-adjusted rates of return.
A+ Investors have access to the A+ Stock Grades Screener. The A+ Stock Grades allow users to evaluate over 6,500 stocks using factors that have been shown to identify stocks that outperform the market in the long term. These factors cover value, momentum, quality, growth and earnings estimate revisions (and surprises).
To identify companies whose stocks are exhibiting deep value and strong price momentum, I used the A+ Stock Grades Screener to first isolate stocks with Value and Momentum Grades of A. As of July 9, 2021, there are 6,573 companies in the A+ Investor stock universe. Of those, 147 have Value and Momentum Grades of A.
While these filters have done an excellent job of narrowing down the universe, this is still too large of a group of stocks to analyze. So I added a third filter that looks for companies with a Quality Grade of A as well. Our backtesting of the A+ Value Grade shows that companies with higher value grades perform better than those with lower value grades. This filter also helps to avoid low-value stocks that may have underlying issues that may warrant their low price multiples.
Adding the Quality Grade of A requirement lowers the number of passing companies from 147 to 36.
This is still a few too many stocks for my liking, so I added two additional filters requiring that a company’s Growth and Earnings Estimate Revisions Grades be C or better. This left me with 15 passing companies.
A subset of this group as of July 9, ranked in descending order by momentum score, is shown below.
Dillard’s Inc. (DDS) has the highest Momentum Score among the 15 passing companies. The company is a retailer of fashion apparel, cosmetics and home furnishings.
Although the company has the highest Momentum Score, its Value Score still ranks in the middle of the pack for this set of companies. The company’s price-earnings ratio of 16.2 ranks in the bottom 40% of the stock universe and is well below the 44.6 price-earnings ratio (P/E) for the typical stock in the department store retailers industry. The price-to-sales ratio of 0.81 ranks in the bottom 17% of all stocks, and is well below the industry median of 4.4. Dillard’s price-to-free-cash-flow ratio of 6.7 is attractive relative to the industry median of 20.6 and is in the bottom 15% of all U.S.-listed stocks.
Dillard’s shares have jumped more than 710% over the last 52 weeks, outperforming the S&P 500 by nearly 490 percentage points. Over the previous four weeks, Dillard’s shares outperformed the S&P 500 by more than five percentage points as they climbed almost 9%.
I have been writing stock screening articles for over 20 years, and each time I add this important disclaimer for those looking at the results of a quantitative screen: The results are the starting point of your analysis, not the finish line.
Screening is beneficial for isolating companies that share common characteristics. But it is still up to you to do additional due diligence before deciding whether any of the companies are suitable for your portfolio.
A case in point is 360 DigiTech Inc. (QFIN), one of the 15 companies passing the high-quality value on the move screen. It is a holding company that mainly operates digital consumer finance platforms. The company provides tailored online consumer finance products to prime, underserved borrowers funded primarily by funding partners. 360 DigiTech also offers standardized risk management service, in the form of software-as-a-service (SaaS) modules to institutional clients.
The company is based in China, and it recently saw its stock price fall 25% after it was revealed that its core app had been removed from the Android app store last week. This move came as Chinese regulators investigate their customer protection practices. Whether this points to broader issues with the company, or a buying opportunity given the sharp price decline remains to be seen.
The research studies by Asness and others provide evidence that combining value and momentum strategies offers investors the opportunity to achieve higher rates of return with lower risk than would be achieved with either strategy individually.
Screening tools such as the A+ Stock Grades Screener help you to quickly identify stocks at the intersection of deep value and robust momentum.
