Value InvestingInvesting UniverseValue Investing is well suited to Large Market Capitalizations which constitute the main universe. Here are some good starting points to fish for Value stocks:
According to them, a good Zacks rank might be the catalyst for a Value stock to start performing. You may relax the ranking to include both Zacks rank 1 and 2. In this case, don't forget to increase the number of holdings when dealing with smaller Cap. Primary Theme Go back to TopValue investors look for stocks selling at an attractive price compared to 2 types of measure:
Most of these studies assume that you’re buying a large number of value stocks (≥25). Although it is now possible to invest in a large number of stocks at low cost with a Stock Basket Account, some investors may not want or may not have access to such low cost Broker. In order to bring the portfolio down to a lower number of stocks, further filtering is required. A simple approach is to screen for stocks that pass through 2 valuation measures, for instance from 2 different groups. Example: buy stocks that have low Price/Earnings ratio (Income Statement) and low Price/Book-Value ratio (Balance Sheet). It is not recommended to screen with more than 2 valuation measures: there will be overlaps and you'll reach a point of diminishing returns where your screen will start to actually flash many real dogs. Discount to Intrinsic value is seldom used in a Value screen, except if included in a Stock Rating. In fact, much less studies and backtesting have been performed with Discount to Intrinsic value because it is more complex to compute and it requires assumptions in growth rate. Thorough academic studies are therefore more difficult. Finally, few screeners provide a Discount to Intrinsic value measure. Secondary theme Go back to TopQuality is the main secondary theme used to increase the robustness of a Value Investment Strategy.If the Investing universe used is not a major Index or a Stock Rating focusing on Quality, then it is recommended to add a Quality criterion in your screen. Indeed, Value stocks are often those that have fallen out of favor: Slumping Industry, Profit Warning... Therefore, a Quality theme in the screen allows to filter the companies that are strong financially and have a higher chance to withstand a temporary setback. Quality criteria include low Debt, Positive Cash Flow or Positive Earnings... Ranking Go back to TopValuation ratios constitute the main ranking parameters, especially when none has been used in the screening.Many simple strategies just use an Investing Universe and then rank stocks based on a Valuation ratio: Dogs Of the Dow is one such strategy. Using Momentum (Relative Strength) in a Value screen ensures that you’re buying a Value Stock when the Market has started to realize its potential. This is especially important with smaller Caps that have not yet been discovered by the investment community. This approach has been popularized by James O’Shaughnessy in What Works on Wall Street where he showed that Ranking Value screens with Relative Strength and buying top ones is among the best mechanical strategies. Now, Momentum increases Volatility so add Relative Strength only if you can stomach higher risk. Holding Periods Go back to TopValue Investing requires longer holding periods as it can take time for the market to discover a stock’s true value. Benjamin Graham keeps his value stocks for up to 2 years, Warren Buffett forever.In "Contrarian Investment Strategies: the next generation", David Dreman shows that Value Investing can provide outperformance with holding periods of 8 years. It means that you can Buy and Hold a Value portfolio for 8 years, it will still outperform the market. Value screens should have holding periods ≥ 1 year. Reciprocally, whatever your investing strategy, always include a valuation measure in any stock screening with holding period exceeding a year. Value Investing characteristics Go back to TopValue Screens often exhibit the following characteristics:
Sample Mechanical Value Investing Screens Go back to TopThe following table summarizes the main criteria for building successful Value Investing strategies. In addition 2 popular simple value screens are shown: the Dogs of the Dow and James O'Shaughnessy's Reasonable Runaways (Value + Momentum).
As you can see, successful Value Investing is pretty simple. You can screen for value stocks at the Stock Screener. |
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