What are we looking for?
U.S. large and mid-cap value stocks.
Value stocks tend to be some of the best performers after a market correction. Value stocks, or stocks that are currently trading below their expected worth, tend to get hit hard during periods of volatility. Afterward, however, they can be an excellent place to look for ideas as their recovery tends to be strong.
Today I’m going to repeat my study from last month, which looked for Canadian value stocks, this time with the focus on the U.S.-listed shares. This strategy will search for value stocks within the CPMS U.S. universe, which today comprises 2,090 companies. 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 preferred;
- Trailing free cash flow, a profitability metric – the latest four quarters’ free cash flow per share, high values preferred;
- Price-to-trailing-cash-flow, measured as the company’s most recent share price divided by the trailing four quarters of cash flow per share, low values preferred;
- Price to book value – measured as the company’s most recent share price divided by the company’s adjusted book value, low values preferred;
In order to qualify, stocks must have a trailing P/E in the bottom half of all U.S. stocks (that value today is 20.99 or below). To ensure companies are not overleveraged, they must have a debt/equity ratio of no more than 1.1. Stocks must also have a positive trailing free cash flow, as well as a trailing return on equity (a profitability metric) in the top third of peers, which today equates to a value of 16.76 per cent or higher. Lastly, stocks must also have a market capitalization in the top third of peers (that value today is roughly US$5.6-billion or higher).
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.
What we found
I used Morningstar CPMS to back test this strategy from April, 2004, to April, 2020. During this process, a maximum of 15 stocks were purchased. No more than three 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 trailing P/E rose into the highest third 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 10.6 per cent while the S&P 500 Index returned 8.5 per cent on the same basis.
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.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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