Decades of academic research by quants, fund managers and institutional investors alike have found that a combination of Value & Momentum factors in stocks typically lead to market-beating returns.
Investment Guru and US Fund Manager, James O’Shaughnessy has been a strong advocate of ‘Trending Value’. In his book What Works on Wall Street, he explains that using several valuation ratios and combining them with improving price strength forms the basis for what has been one of the most effective stock market strategies.
But what is it that makes Value & Momentum such a successful stock market strategy and how does this apply to Phoenix Group Holdings (LON:PHNX)?
The value component…
Cheap stocks have been shown to outperform expensive stocks over long-time frames. Therefore, finding stocks with a high Earnings Yield and low Price to Sales can be a good place to start in identifying attractively priced stocks.
The Earnings Yield takes a company’s profits and compares it to its current market valuation (enterprise value). Using the enterprise value takes into account cash and debt and the calculation gives us a good idea of the total value of the stock. Expressed as a percentage, a high Earnings Yield is a good sign of value. A good rule of thumb can be to look for an Earnings Yield above 5%, Phoenix Group beats this comfortably, with an Earnings Yield of 12.3%.
The Price to Sales ratio tells us how cheap/expensive a company is relative to its current sales. The calculation is quite straightforward, taking the current share price and dividing this by its sales per share. A Price to Sales ratio of less than 1 is said to offer good value. Phoenix Group is well below this level, with a Price to Sales ratio of 0.17.
However, exposure to value as the only factor can increase the risk of finding value traps, which are cheap for a reason and often fail to recover.
… and the momentum driver
Although momentum inherently goes against investor psychology, it has proven to be one of the greatest tools investors can use when combined with other factors such as quality and value.
Trend following and momentum investing are often very effective strategies, although when momentum turns losses can mount quite quickly. Whilst value can take time to be realised momentum works very well during bullish, trending periods. To assess price momentum we can use Relative Strength, which compares the share price change to the underlying market index over a specified period of time.
Outperformance and strong momentum is a good indicator that a share might continue its upward trend. Phoenix Group’s Relative Strength over the past 6 months stands at an impressive 10.2%.
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.