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What we are looking for?

This week we have been running a series of screens to find undervalued stocks developed by best-selling author James O'Shaughnessy, a quantitative analyst.

Mr. O'Shaughnessy is the author of What Works on Wall Street and his firm O'Shaughnessy Asset Management LLC oversees the RBC O'Shaughnessy family of mutual funds.

Today, we add some complexity to the “cornerstone growth strategy,” the foundation of which is the price-to-sales ratio (PSR). Mr. O'Shaughnessy calls the PSR the “king of value factors” in his stock selection system because it is the most consistent and strongest indicator of an undervalued stock.

This week we have presented the lowest PSR for both Canadian and U.S. common shares. The PSR is calculated by dividing the stock price by the annual revenue per share.

Using the PSR base, we will add several more criteria. The stocks must have a PSR of less than 1.5; they must show positive earnings growth over the past year; and the change in their stock price over the past three and six months must have been above average. The stocks that fit all those criteria are then ranked according to their price change over the past 12 months.

Today we look at Canadian securities and tomorrow we will use the screen on U.S. companies.

More about today's screen

The data base consists of all Canadian securities covered by Compustat North America. For the purpose of today's table, the companies must trade at a share price of more than $1 (U.S.) and they are excluded if the market value is less than $200-million. Also excluded are all investment trusts, mutual funds and limited partnerships as well as securities that appear in both the Canadian and U.S. industrial files of the Compustat data base.

What we found

What a rebound. Many of the top-ranked shares have doubled, tripled, quintupled and in one case posted a ninefold share price increase during the past year. Typically there is a one-year hold period, but there are “red flag” events that can cause us to close out a position early, said William Latimer, managing director, research director and portfolio manager for O'Shaughnessy Asset Management.

It has been a “junk rally,” with the worst-performing stocks that were being priced for extinction in the panic selloff transforming into the best performers, and there are more gains to come, according to research by O'Shaughnessy Asset Management. These stocks tend to outperform for the market for another six months after a huge rally.