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.
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. 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 February only 21 stocks met our criteria. Today only 18 stocks do. Several are small cap firms that cautious investors may want to sidestep.
On the other hand, the list also contained several big firms – notably the smartphone maker Research In Motion and the miner Sherritt International.
It's important to note that stocks tend to be cheap for good reasons. You should do your own research before buying any of these value pentathletes. But Mr. O'Shaughnessy's research indicates that stocks that excel in all five categories have a habit of doing better over time than the broad market.
His back test selected U.S. stocks that scored well on all five criteria. 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.