Value Screening in an Improving Stock Market

Friday, September 24, 2010

Since I wrote “Value Screening US Stocks – Example with 7 ‘Picks’” (September 1), the stock market has risen over 5%. What’s happened to the screening results, and what should we do now?

Sticking to the same value screens in a rising market can result in a shrinking list. Worse, as prices improve throughout the stock market, the companies still passing the filters can become an odd set, with flaws not apparent in the screens.

However, we are not there yet. Value screens are still useful.

First, here is what now passes through using the screens I discussed previously.

Allstate (ALL) and AFLAC (AFL) didn’t make the cut, having risen above some of the price sensitive values. We’ll discuss them after looking at the following set of results.

In a rising market, it is acceptable to adjust the screens a bit, while still looking for attractive valuations. This next table shows the additional companies that currently pass through.

Notice that almost all the adjusted filter levels (in red) are slight adjustments. With valuation measures, we would expect earnings and dividends to keep pace somewhat as prices rise. The red numbers for the companies are those values that prevented them from showing up in the first table.

With purely technical measures, there are two different adjustments. First, only a small one for price relative to the 52-week high. This is because, even in a rising market, individual stocks gyrate. Therefore, we want to keep an eye out for short-term dips of about 10% or so below the 52-week highs.

On the other hand, once the stock market enters an uptrend, the 200-day moving average is always playing catch-up, often well below the current stock price. For now, it’s okay, so I adjusted the filter upwards by 5%, about as much as the market rise. In a true bull market, I would just drop it from the screening, adding in measures that are more appropriate.

Notice that AFLAC is back with the adjusted filters. However, Allstate’s rise pushed its current P/E ratio above even the adjusted level.

So… The value screening is still turning up higher quality investment opportunities. However, if the market continues to improve, especially relative to company fundamentals, such screening will become less useful. Eventually, we will have to pull out our growth-oriented selection processes.

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John Tobey on Seeking Alpha

Seeking Alpha Certified

September 2010