If you are looking through the rubble of the stock market in search of beaten-up bargains, George Vasic at UBS recommends ignoring those stocks that have lagged the most from their recent lows and instead concentrate on stocks that have the best upside potential relative to their downside risk.
For upside potential, he looked at stocks that are furthest away from their 12-month target prices – 28 stocks in the financial, telecommunications and industrial sectors. For the downside risk, he looked at what happens in a so-called Black Skies scenario, where another recession sets in and the stock market turns dangerous.
He then compared the two figures to come up with a ratio of upside potential to downside risk – where a big number is good and a small or negative number is bad.
Using this approach, Magna International Inc. comes out on top, with an estimated 58 per cent upside to a mere 10 per cent downside. The other stocks in the top five: Bombardier Inc. , Thomson Reuters Corp. , Viterra Inc. and Linamar Corp.
Meanwhile, there were four stocks that had low upside and relatively high downside risk: Bank of Montreal has a mere 6 per cent upside, according to analyst estimates, but a 39 per cent downside. Canadian National Railway Co. , Rogers Communications Inc. and Bell Aliant Inc. also scored poorly.
“Investors also appear to be doing this type of reward/risk calculation using 52-week highs and lows, but this can overlook instances where the landscape has changed,” Mr. Vasic said in a note. “Indeed, 23 of the 28 stocks on our list have less appealing upside/downside ratios than when calculated using 52 week highs/lows.”
Insurance stocks come out looking better using this approach – but Mr. Vasic cautions that lower-for-longer bond yields definitely put them in a changed landscape.