Monday, 29 September 2014

Value with Momentum

Momentum helps is that it provides an answer one of the biggest issues of value investing, namely the when will it happen? question.
  • Imagine you’ve found a neglected jewel which you expect that will ultimately capture an upside of, say, 75%...  
  • But, when will it happen? In 3 yrs, 5 yrs, 7 yrs..?
  • Those periods equate to IRRs of 20.5%, 11.8% and 8.3% pa respectively. 
  • Assume a catalyst exists that’s successful in prompting a realization of that full 75% upside within 1 year. That is, of course, a 75% IRR!
 
How to find under-valued, out-of-favour companies at the point when the market is starting to recognize them?
  • Discover a group of value stock by examine the price-to-book, price to-cash flow, price-earnings and price-to-sales ratios.
  • Ascertain which of them are likely to rebound versus being cheap for a reason, such as being near bankruptcy. 
  • Look for sign of momentum
    • in terms of price momentum (relative strength) 
    •  in terms of improving analyst sentiment and earnings surprises.
 
Some examples of possible catalysts include:
  1. Fresh management with new direction 
  2. A change in strategy of existing management (e.g. new product strategy, business reorganization  or  cost  reductions)
  3. disposal  or  purchase  of  a meaningful asset 
  4. A recapitalization of the business
  5. takeover bid, or 
  6. Activist shareholders who may put pressure on management to act.

Screen Criteria
  1.  At least one of P/B, P/CF, P/E or P/Sale more favourable than the industry
  2. 6 month relative strength (% gain vs S&P) > 0
  3. 3 month relative strength >= 6 month relative strength
  4. Earning suprise by examines three inter-related measures
    1. Standard earning surprise - most recent interims vs forecasts
    2. Abnormal returns around recent earnings announcement
    3. Revision in the analyst consesnsus - now or trending over the last 6 months

Diversification & Portfolio
  • No one stock makes > 1.6% of the portfolio
  • No single industry make up more than 3% relative to the weight in the corresponding benchmark
  • Ruled out stocks than have been public < 2 years

References:-

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