Tuesday, November 15, 2016

Stock fundamental ranking and screening with James O'Shaughnessy Trending Value

James Patrick O’Shaughnessy is the founder of quantitative money management firm O'Shaughnessy Asset Management, LLC.

In 1996, he wrote the best selling book "What Works on Wall Street", which has now evolved to its 4th Edition.

In the 3rd Edition of this book published in 2005, O'Shaughnessy unveiled the Cornerstone Growth stock screening method, which is based on the following criteria:
  • Market capitalization >= $225 million
  • 3-month average daily share volume >= 100,000
  • Price-to-sales ratio <= 1.5
  • 3-month total return greater than the median return of Russell 3000 companies
  • 6-month total return greater than the median return of Russell 3000 companies
  • Trailing 12-month EPS > 0
  • Rank by highest 12-month total return
Subsequent to that, the 4th Edition of the book, published in 2011, introduced the improved Trending Value growth stock screening method, which claimed to achieved 21.19% annualized return over the 46-year period between 1964 and 2009.
Trending Value uses “value composite” (VC) instead of just the Price-to-sales ratio to measure stock undervaluation, which O'Shaughnessy described as "the top stock-market strategy of the past 50 years".

The value composite is composed of 6 value factors:
  • Price-to-Book
  • Price-to-Sales
  • Price-to-Cashflow
  • Price-to-Earnings
  • Shareholder Yield
Listed companies in a stock market are divided into 100 groups (percentiles) based on the 6 value factors above. If a company's price-to-book ratio is in the lowest 1% of the dataset, it gets a score of 1. For some ratios it's the other way around, for instance EBITDA/EV. If a company belongs to the highest 10%, it gets a score of 1. If a value is missing, it gets a score of 50.

The same calculation is repeated for each of the ratios and then their values are summed up together. Companies are again divided into 100 groups based on this score. This final result is the so-called value composite.

A value composite of 1 means that the company belongs to the 1% cheapest companies according to these factors.
In the next filtering process, only the top 10% stocks ranked according to this value composite score are selected. Then these stocks are further filtered by a momentum factor, i.e. the 6-month price index. The result is an extremely cheap group of stocks that have been on the rise during the last 6 months.
O'Shaughnessy tested 3 different value composite scores as follow:
  • VC1: based on the first 5 ratios only, excluding shareholder yield. By using this ratio his backtests showed a return of 17.18% annually.
  • VC2: based on all 6 ratios. O'Shaughnessy uses this ratio in his trended value screen since his backtests showed an improvement in overall annual compound return of 12 basis points to 17.3%, a reduced standard deviation and downside risk.
  • VC3: same as VC2 but the last ratio is replaced by buyback yield. Some investors are indifferent whether a company pays out a dividend or want to avoid these since they can be very heavily taxed. This VC generates an even higher return of 17.39% annually but with a slightly higher standard deviation compared to the VC2.
At the time of writing,  ValueSignals website ranked KLM Royal Dutch Airlines (KLMR.PK) with the following scores:
  • VC1: 1
  • VC2: 1
  • VC3: 1

The value factors of KLMR.PK compared with the entire market, the Industrials sector, the Transportation group, and the Airlines industry, respectively, is as below:

However, KLMR.PK only ranked at 4,842 in Magic Formula screening method:

Anyhow, it still has a respectably high Piotroski F-Score:

ValueSignals website provides a very handy and straightforward online service for systematic value investing to perform quantitative stock screening, stock comparison and stock information, currently covering as many as 33,600 stock counters listed in 44 countries around the world.

Beside O'Shaughnessy Value Composites, ValueSignals website is also able to perform screening (including multifactor cross-screening) of:
The screening can be performed across all stock counters, or limited to within certain regions,  countries, industries, etc.

As a user of ValueSignals, I recommend this website to all serious value investors and fund managers to boost your stock screening and selection process.


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