Value U.S. stocks that could outperform volatility

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With a rocky start to Q1, the S&P500 has certainly shown some volatility in recent months, as evidenced by the orange line of the S&P 500 Composite against its moving averages over the last 18 months, below:

Despite this, on a trailing 12 month basis, the index still maintains a positive 17.1% total return. For investors who believe that the general trend of the market will continue in the positive direction, the recent volatility may provide an opportunity to find some value focused names with a long-term growth trajectory. To find these names, I used Morningstar CPMS to rank stocks on the following factors:

5 year Normalized EPS growth rate (this measures on average, how much earnings have grown each year in the last 5 years)
Deviation of EPS over 5 years (a risk metric that measures how stable companies earnings have been over the trailing 5 years, lower figures preferred)
Median Estimated EPS Growth Rate (how much analysts are expecting earnings to grow in the upcoming fiscal year)

To qualify in our strategy, companies must have Price to Earnings, Price to Book, and Price to Sales ratios less than the median of the sector to which it belongs. In addition, these same valuation metrics must currently be less than the 10 year median of the stock’s own history. Lastly, companies must have at least three active analysts covering the stock. What we found I used Morningstar CPMS to back test this strategy from February 1994, to March 2018. During this process, 20 stocks were purchased and equally weighted with a maximum of five stocks per economic sector. Once a month, we sell any stocks that rank below the top 50% of the CPMS Universe on the above factors (today this universe consists of 2187 companies). When this happens, we sell the stock and replace it with the highest ranked stock not already in our portfolio. Over this period, the strategy produced an annualized total return of 13.1% while the S&P 500 Total Return Index produced 9.7%. The chart table shows a clear picture of how such a strategy would have outperformed the market (S&P 500):

Additionally, the return distribution of the portfolio are shown below. Note the outperformance during down markets:

The stocks that qualify for purchase into the strategy today are listed in the table below. As always, it is advised that investors conduct their own independent research before buying or selling any security.

Data as of March 19^th, 2018. Source: Morningstar CPMS

More about Morningstar

Ian Tam is Manager of the Client Services team at CPMS, a division of 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.

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