WHAT ARE WE LOOKING FOR? Let's uncover the most likely value traps on the S&P 500. Yesterday, we got some help from Myles Zyblock, chief institutional strategist at RBC Dominion Securities Inc., on finding value stocks that have the best chance of rising. Today, we'll use his research to find cheap stocks that are likely going to keep heading down further into the bargain bin. HISTORICAL RESEARCH As we said yesterday, Mr. Zyblock believes that one of the best ways to buy stocks over the long term is to pay close attention to low price-to-earnings ratios. Since 1980, a portfolio of the cheapest 20 per cent of the S&P 500 index defined by low P/E ratios has produced an annualized return of 17 per cent (rebalanced quarterly), which is 2.7 percentage points better than the index as a whole. "This strategy has outperformed the benchmark in each five-year interval since 1980, it has outperformed in market downturns and it has delivered these gains in a superior risk-adjusted manner," Mr. Zyblock said. But Mr. Zyblock also noticed that about 40 per cent of the constituents of the low P/E group actually have negative returns in any given quarter and only about half actually beat the S&P 500. This means the winners are handily beating the losers. Mr. Zyblock's testing found that those low P/E stocks that have a high degree of fundamental momentum or predictability will generally perform the best. (Predictability is judged by total return stability, earnings stability, earnings estimate confidence and low non-recurring item frequency. Momentum is judged by earnings momentum, revenue momentum, total return momentum, positive earnings estimate revisions and positive earnings surprises.) Yesterday we looked at the low P/E stocks with the best momentum and predictability. Today, we'll look at the ones with the worst, hoping this gives us a list of stocks to avoid or even short.
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