What are we looking for?
Value-oriented stocks within the U.S. universe picked with an emphasis on timing.
Value strategies typically search for stocks trading below their "intrinsic value," rendering them undervalued compared with peers. A stock's intrinsic value is its perceived "true value" and represents the theoretical price the stock should eventually achieve when properly valued. A common way to look for these types of stocks is to search for companies with a low price-to-earnings multiple compared with peers, signalling that such a company is currently undervalued relative to other stocks. The difficult part, however, can be finding undervalued companies that are going to start increasing in value and avoiding those that are going to continue to decline.
Today's strategy looks to find U.S. value stocks that are also experiencing a positive price movement relative to their 200-day moving average. This strategy ranks stocks using the following factors:
- Price-to-trailing-earnings (measured as the company’s most recent share price divided by the previous four quarters earnings per share – low values are best);
- Free cash flow (a profitability metric: the latest four quarters’ free cash flow per share – high values are best).
In order to qualify, stocks must have both a trailing P/E in the bottom two-thirds of all U.S. stocks (that value today is 21.07 or less).
To ensure companies are not overleveraged, they must have a debt-to-equity ratio of no more than 1.1. Stocks must also have free cash flow per share in the top one-third of peers (today, this value is $2.61 or more). Lastly, in order to help with timing when making purchases, a stock's price change relative to its 200-day moving average must be greater than 3 per cent.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back test this strategy from April, 2004, to January, 2018. During this process, a maximum of 15 stocks were purchased.
No more than five stocks could be held in any one sector at any given time. Stocks were sold if the company's debt-to-equity ratio grew to more than 1.3; or if the company's free cash flow dropped below the top two-thirds of peers.
When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio.
Over this period, the strategy produced an annualized total return of 14.3 per cent while the S&P 500 Total Return Index gained 9.3 per cent across the same period. Stocks that qualify for purchase into the strategy today are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Select value-oriented U.S. stocks
|Rank||Company||Symbol||Market Cap (US$Mil)||Div. Yield (%)||Trailing P/E||D/E Ratio||FCF ($/Share)||Price Chg. Rel. to 200D MA (%)||Recent Price (US$)|
|2||Express Scripts Holding||ESRX-Q||42,347.7||0.0||10.5||0.9||9.93||13.5||74.77|
|4||Tech Data Corp.||TECD-Q||3,988.9||0.0||13.0||0.7||18.36||7.1||104.55|
|5||Reinsurance Group America||RGA-N||9,716.6||1.3||13.9||0.4||22.43||5.2||150.87|
|6||World Acceptance Corp.||WRLD-Q||1,013.7||0.0||14.2||0.8||21.93||34.0||111.63|
|7||Stifel Financial Corp.||SF-N||4,312.8||0.8||14.7||0.3||10.21||18.2||62.99|
|8||Lam Research Corp.||LRCX-Q||31,699.2||1.0||14.2||0.3||9.83||9.6||194.53|
|9||State Street Corp.||STT-Q||38,338.9||1.6||16.4||0.5||16.52||9.6||104.28|
|10||Polo Ralph Lauren Corp.||RL-N||8,652.5||1.9||17.7||0.2||10.62||19.6||106.44|
|13||Jones Lang LaSalle Inc.||JLL-N||7,295.4||0.5||18.1||0.4||9.69||19.2||160.81|
|15||Valero Energy Corp.||VLO-N||40,345.0||3.5||18.5||0.4||8.94||18.8||92.20|
Source: Morningstar Canada