3 Stock Picks According To This Quantitative Strategy

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Includes: MU, SAFM, TPCA
by: Ruerd Heeg

Summary

I try to find stocks in a systematic way, using quantitative stock selection.

A great strategy developed by James O'Shaughnessy combines value with momentum.

Here I discussed the 3 best stocks according to this strategy.

In What Works on Wall Street, James O'Shaugnessy describes more than a hundred quantitative stock strategies. He investigates their long-term returns and risks. Last year, I discovered it is possible (but not easy) to implement many of these quantitative strategies. So these advanced strategies are not just an edge for hedge funds anymore but anyone can implement them at home. It can be done by screening for stocks using very flexible criteria. Then export fundamentals and price data for each stock and then rank them on multiple criteria. Finally, compute the combined ranks.

One of the best strategies described in What Works on Wall Street is a mix between value and momentum called Trending Value. He ranks US stocks with positive momentum on various value factors and then proceeds with the 10% with the best rankings. These best 10% he ranks on momentum. The 25-50 stocks with the best momentum enjoy high returns (21%) despite low risks (Sharpe ratio 0.9).

I have done something similar. One of the biggest differences is that I rank on smooth momentum instead of on raw momentum. For more details see my previous article on trending value stocks and see also this overview article.

For international stocks, I share the details of the best-ranked stocks with my Marketplace subscribers. For the much more expensive US-listed stocks, I share results here on the free part of Seeking Alpha.

I will briefly discuss the best-ranked stocks based on last week's price data. The three value stocks with the best momentum are the following:

  1. Micron Technology (MU)

  2. Sanderson Farms (SAFM)

  3. Tropicana Entertainment (OTCQB:TPCA)

Micron Technology

Since last month the stock went up from $43.20 to 45.80, or 6%. See also the discussion of Micron in my previous article (link above).

Stephen Breezy published a new article after a pause of several months. Though his focus was on Intel (NASDAQ:INTC), he also mentions two interesting facts on Micron Technology. First, he writes Samsung Electronics (OTC:SSNLF) also has a license allowing the company to produce very fast non-volatile memory, a la 3D XPoint also known as Optane. This is a negative for Micron. Second, he mentions the joint venture between Intel and Micron has stopped producing NAND memory and is now fully used for producing 3D XPoint memory.

A positive development for Micron Technology is the new processor bugs: Meltdown and Spectre. Hackers can exploit these bugs for hijacking sensitive information such as passwords. From what I read, the Meltdown bug only applies to Intel processors but the Spectre bug can be exploited with processors of many chip manufacturers.

Exploiting the Meltdown bug can be prevented at the operating system level, slowing down processors about 10%. I guess this will increase the probability old Intel-based computer systems will be replaced if the operating system cannot be updated. However, I do not think there are many of these old systems.

The Spectre bug is very difficult to exploit but exploiting is also very difficult to prevent on the software level. I guess almost all phones and tablets are vulnerable. These small computers often carry sensitive information such as passwords. Moreover, lots of these computers have operating systems that do not get updated, in particular, most Android phones and tablets. Therefore, the best remedy against exploiting the Spectre bug is replacing your phone and tablet as soon as safer processors are available.

The Spectre bug might trigger massive device replacements in the near future. That will certainly increase demand for memory chips and therefore will be good for Micron Technology.

Micron is cheap based on EV/EBIT, eight-year retained earnings/market cap, price/free cash flow, and P/E. Another great fundamental is its Piotroski score of 8. A negative is the massive trading liquidity in terms of three-month average volume/public float. In the ranking just based on value metrics and liquidity, 82.38% of the stocks (with positive momentum) are more expensive than Micron.

Sanderson Farms

Sanderson Farms (NASDAQ:SAFM) is one of the biggest poultry producers in the US. This was once a family business with the 70-year old son of the founder still at the helm. He is both Chairman and CEO. Currently, its market cap is just over $3 billion at a share price of $133.75. The company owns seven big plants and four centers for packing and distributing.

Recently, the stock price went down on missed EPS estimates, signs of oversupply and related reduced analyst ratings. Much of the miss was related to hurricane Irma. See also here. The same author comes up with a DCF valuation of $155.05.

Currently, the dividend yield is about 1.5%. Over the last 10 years, the company always paid a dividend, and payouts have been increasing. The company also spent tiny amounts on buybacks. I am, however, a bit skeptical about corporate governance, however, after discovering the following line in a supplement on last proxy filing: The preventative use of antibiotics in food animals has not been shown to harm human health. I know a couple more of these statements: Smoking does not cause lung cancer, a sedentary life does not cause obesity, and fossil fuels have nothing to do with global warming. See also here.

Similarly, the large (14 directors) and staggered board tends to be a good predictor of lower returns. Each year shareholders can replace at most five directors. This makes it more difficult for an acquirer or a large shareholder to get control. Both, large boards and staggered boards alone tend to predict lower returns. I suppose their combination does even more so.

The balance sheet is very strong with low leverage, no debts, and lots of cash. Despite the strong balance sheet, the company has filed a shelf registration statement.

Sanderson Farms financials reveal many multi-year metrics suggesting the company has good competitive advantages. First, the seven-year average gross profit/(total assets - excess cash) is high and rose significantly. There was some volatility though because seven years ago the gross profit was negative. Other multi-year metrics are also good: Seven-year averages of return on assets and return on capital and the seven-year sum of the free cash flows relative to total assets.

Substantial shareholders: CEO and Chairman Joe F. Sanderson Jr. 3.84%, BlackRock (NYSE:BLK) 8.54%, The Vanguard Group 7.39%, AJO LP 5.4%. Other directors and executives own together about 2%.

Sanderson Farms is cheap based on EV/EBIT, eight-year retained earnings/market cap, price/free cash flow, and P/E. Another great fundamental is its Piotroski score of 8. One negative, in my opinion, is the massive trading liquidity in terms of three-month average volume/public float. In the ranking just based on value metrics and liquidity, 90.24% of the stocks (with positive momentum) are more expensive than Sanderson Farms.

Tropicana Entertainment

Tropicana Entertainment owns seven casinos in the US and a combined resort and casino in Aruba. In addition, the company operates a social gaming website. The market cap is about $1.36 billion at a share price of $57.25.

Another writer on Seeking Alpha thinks the company will be acquired by Icahn Enterprises (IEP). He noted that Carl Icahn valued the company at $48.27 per share on December 31, 2016. But in August 2017, the company spent another 36 million buying back shares at $45 per share. I think this suggests a higher fair value. In the same tender offer, Icahn Enterprises bought shares for $104 million also at $45 per share. After the last tender offer, Icahn Enterprises owns 84.6%.

Certainly, Tropicana Entertainment is cheap: based on EV/EBIT, EV/gross profit, eight-year retained earnings/market cap, price/free cash flow, and P/E. Another great fundamental is its Piotroski score of 8. Another positive is the low trading liquidity in terms of three-month average volume/public float. A positive is also the strong balance sheet with very low leverage. In the ranking just based on value metrics and liquidity, 96.75% of the stocks (with positive momentum) are more expensive than Tropicana Entertainment.

Another attractive metric is the pretty constant and high seven-year average gross profit/(total assets - excess cash). A constant or increasing ratio suggest a competitive advantage.

In my opinion, Tropicana is clearly worth more than $45 but how much more? Is $57.25 a fair price or is it still undervalued at the current price? Without growth, the multiple EV/EBIT of around 10 suggests the stock is fairly valued. But I think some growth can be expected. That growth is probably not priced in yet.

Time will tell when and at what level Tropicana Entertainment shares will peak. In the meantime, various value metrics suggest the stock is still relatively cheap in the otherwise expensive general market.

Disclosure: I am/we are long MU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.