What are we looking for?
U.S. value stocks experiencing upward momentum.
A few weeks ago, we looked at Canadian value stocks with positive momentum. This week, we will be repeating the same exercise but looking at the U.S. marketplace.
To recap, value investors look for stocks that are considered undervalued, that is, stocks currently trading at a discount relative to their “intrinsic value” – the value the stock is expected to be worth based on analysis.
Today’s strategy couples that traditional value philosophy with several momentum factors to help combat the risk that accompanies any value strategy – that stocks will continue to fall in value rather than rise as expected. The momentum factors chosen are in place to help select stocks that appear to be on an upward trend and avoid stocks poised for a decline.
This strategy looks for American stocks within the CPMS U.S. universe (today, this universe consists of 2,200 names). Stocks are ranked based on trailing price-to-earnings (lower value is best); quarterly earnings momentum (measured as the growth in the most recent four quarters' earnings relative to the most recent four quarters' earnings lagged by one quarter – higher value is best); and a stock’s price change from its 12-month high (a momentum factor, least-negative value is best). In order to qualify, stocks must have:
- Quarterly earnings momentum greater than zero;
- Quarterly earnings surprise (proprietary measure of the difference between actual and expected quarterly earnings, higher value is best) greater than zero;
- Annual earnings momentum (measured as the growth of annual earnings per share) greater than zero;
- Trailing P/E in the lowest two thirds of peers (today this value is a P/E less than or equal to 26.4).
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 December, 1993, to June, 2018. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their quarterly earnings momentum or their quarterly earnings surprise dropped below minus 10 per cent. 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 15.6 per cent while the S&P 500 Total Return Index returned 9.7 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.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.