Oversold Large Stocks - An Investment Opportunity?

by: Alan Brochstein, CFA

Beating the S&P 500 (NYSEARCA:SPY) consistently over time is no easy task. The rise in indexing by institutions over the past couple of decades is certainly a reflection on this observation.

During my CFA program studies 12 years ago, I came to the conclusion that indexing is the rational choice for most investors for large-cap securities and fixed-income, while active management is more likely to be a worthwhile endeavor in markets that are less efficient. With so many bright analysts, professional investors and the media focused on the types of companies in the S&P 500, it is little wonder that overcoming a 1% fee hurdle plus transaction costs (bid-offer, commission, market impact) is so challenging. With that said, I think that one of the ways to overcome these obstacles is to use mean-reversion at appropriate times.

The large-cap universe consists predominantly of slower-growing companies than the overall market. The information about these companies is widely and often rapidly disseminated, and the institutional ownership of these companies tends to be very high. As a result, when there is new information, the market can sometimes overreact. While this isn’t always an opportunity to take a position, it often can be.

With that in mind, I used StockVal to take a look at the S&P 500. I wanted to identify stocks that were “oversold” using a measure that reflects the number of standard deviations the short-term price is from a longer-term average, hoping to find some potentially attractive entries in large-cap names. I wanted to avoid being “too early” though, so I set constraints to help narrow the list.

On 4/11, there were 59 stocks out of the 500 that were oversold by 1 unit or more. The list had an average year-to-date price decline of -10%. The main factor that I constrained was the earnings estimates. Trying to avoid the falling knife, I limited estimate declines to no more than 5% for this year and 1% for next year. Additionally, I wanted to kick out stocks that were expensive, so I constrained the list to a maximum PE of 1.2X the 5 year forward PE median.

The table below shows the 18 stocks that made the final cut. Note how many are in Finance, which happens to be the largest sector of the index. Note also that not all of these stocks are down year-to-date (though the list averages -8.7%), as several have solely pulled back from early advances. Happy Hunting!

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Disclosure: I have no positions in any of these securities