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13 stocks satisfy pentathlete approach to value investing

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What are we looking for?

The pentathletes of the value-investing world. These are stocks that excel not just in one category that appeals to bargain hunters, but in several.

Our search for stocks that can score well on several value tests is inspired by money manager James O'Shaughnessy. In the recent update to his classic What Works on Wall Street, he argues that any single value indicator is likely to go through periods when it doesn't work. A more robust strategy, in his opinion, is to look for stocks that satisfy several criteria.

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More on today's screen

One approach Mr. O'Shaughnessy explores is to seek stocks that score highly on five classic tests of value. We applied his suggestion to stocks trading on the Toronto Stock Exchange and adapted his strategy by searching for stocks that:

-have a price-to-book ratio below one;

-have a price-to-sales-ratio below two;

-have a price-to-earnings ratio below 10;

-have a price-to-cash flow ratio below 10;

-have enterprise value to EBITDA of less than six.

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Enterprise value is the total market value of a company's stock and net debt. EBITDA is earnings before interest, taxes, depreciation and amortization.

To avoid micro-cap stocks that may be too risky we required each stock to have a market capitalization of at least $100-million.

What we found

When we ran a nearly identical screen in June, 2012, 18 stocks met our criteria. Today, only 13 do. That is one indication of how much the market has moved up since then. Value stocks are becoming scarce.

Many of the value stocks that do exist are cheap for good reasons. Case in point: A high proportion of today's offerings are in the gold mining sector, which has been hit hard by the metal's lacklustre recent performance, as well as rising costs and resource nationalism.

You should do your own research before buying any of these value pentathletes. But Mr. O'Shaughnessy's research indicates that stocks that score well on these criteria have a habit of doing better than the market.

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His backtest selected U.S. stocks that scored well on all five value metrics. Between 1964 and 2009, they produced an annual average return of 17.2 per cent compared to 11.2 per cent for the broad market. In the market marathon, these pentathletes shine.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More


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