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Mitch Zacks, senior portfolio manager at Zacks Investment Management and “the firm’s primary expert on quantitative investing,” is the latest contributor to Wiley’s “little book big profits” series. Not surprisingly The Little Book of Stock Market Profits: The Best Strategies of All Time Made Even Better (2012) describes some of the strategies that are inextricably linked with the Zacks name. The author also draws on academic findings summarized in Leonard Zacks’s Handbook of Equity Market Anomalies.

In eleven chapters the author discusses such topics as changes in sell-side analyst recommendations, smaller cap stocks, earnings estimate revisions, price momentum, piggybacking on the trades of insiders, net stock issuance (IPOs, stock buy-backs), quality of earnings, valuation metrics, post-earnings announcement drift, seasonal timing, and multi-factor models.

Despite the brevity of the book Zacks is careful to explain the conditions under which the strategies work, what can derail them, and whether they are effective as stand-alones. Let’s take a single example: price momentum.

The data show two patterns that seem relatively stable, or about as stable as financial data ever become. These two patterns are short-term momentum and long-term reversals. In the short-to-medium term, roughly about a calendar quarter or two, stocks that have gone up in price substantially tend to continue to trend upward. However, over the long term, stocks that performed extraordinarily well over the last few years tend to become losers over the next three to five years. (pp. 64-65)

Even though momentum-based trading was profitable until 2000, the normal relationship between short-term momentum and long-term reversals then broke down, and it was not until 2005 that it was re-established.

Zacks explores specific momentum strategies such as a 12/3 split. “What this means is sorting the universe of stocks into deciles based upon how they performed over the past year, and then holding the portfolio for the next three months. It also looks like performance can slightly be increased if you lag the construction period by one week.” (p. 67) Other momentum strategies that can deliver excess returns are “buying stocks that trade near their 52-week highs and using traditional moving averages.” (p. 68)

Somewhat curiously, at least according to one study, “momentum seems to work better for mid-cap stocks than for either large- or small-cap stocks.” Other studies, however, indicate that “price-momentum-based studies are statistically stronger for stocks with lower analyst coverage.” (pp. 69-70)

Since individual investors, unlike institutional investors, tend to hold losing stocks too long and sell winning stocks too soon, and since these behavioral biases contribute to momentum returns, “we would expect to see stocks with low volume—which would be more likely to be held by individuals—to exhibit stronger momentum returns.” This is indeed the case: “a stock’s past trading volume is a good predictor of how strong the momentum effect is and the extent to which the momentum effect persists.” (p. 74)

Momentum-based returns also seem to be linked to broad-based economic strength. “Over the past seventy years, it looks like momentum based strategies only generate excess returns in periods of economic expansion. Even more interesting, momentum returns turn negative during a recession.” (p. 75)

The Little Book of Stock Market Profits can be used as something of a crib or pony by those who don’t want to spend countless hours reading the academic literature. It’s a fast read and offers useful advice for the active investor.

Source: Zacks, 'The Little Book Of Stock Market Profits:' Useful Advice For The Active Investor