In the last two mid-month updates of my premium newsletter Extreme Tech Profits, I shared with subscribers a scan built around a discovery I learned from Dr. Len Zacks, founder of Zacks Investment Research. He is the one who taught me to look for what I call a "valuation disconnect"; that is, an event in the life of a company that takes place whenever new earnings information arises unexpectedly. If this new information is positive – e.g., an increase in earnings growth that had not been foreseen by the analysts – it typically causes the stock price to rise over the next few weeks as investors strive to price in that new information.
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I also showed you how, once we add a valuation filter to the scan (I used the Price-to-Sales ratio) we can improve the returns of the scan greatly. If you recall, with our basic scan composed of the following two filters:
% Change in Q(1) EPS Estimates over 4 Weeks > 10%
Price/Sales = Bottom #5 Stocks
and applied to the S&P 500, using a four-week rebalance over a five-year lookback period, I was able to produce the following robust performance:
As you can see, this simple two-filter scan yielded a five-year return of 227.6% ROI, an average compounded gain of 26.8% per year. At that rate, every $10,000 invested becomes $32,759 in just five years. I also showed you a list of five stocks produced by the scan. Of those stocks, while the S&P 500 itself was down about 2%, three of the five produced positive returns, including an 8.3% return for United Continental Holdings (NYSE: UAL) and an amazing 19.2% return for The Mosaic Company (NYSE: MOS).
So here is the additional filter I'm adding in this new version of our scan of the S&P 500:
Average Analyst Rating < 3.0
This means that the average of all analysts that cover the company must be at better than "hold" (1 = "strong buy" and 5 = "strong sell"). In this way we exclude all companies that analysts are merely lukewarm on, or worse.
We will need to put this filter between our earnings estimates revision and Price-to-Sales filters, since we are using the last filter to get us down to a maximum of five stocks. Thus, in this month's iteration of our scan, our strategy now looks like this:
-- All S&P 500 stocks
-- % Change in Q(1) EPS Estimates over 4 Weeks > 10%
-- Average Analyst Rating < 3.0
-- Price/Sales = Bottom #5 Stocks
And here are the returns, using the same four-week rebalance period and the same five-year lookback period (November 2013 to November 2018):
Wow! With this addition of one simple filter, we have improved our overall ROI from 228% to over 350%, which works out to a 35.2% average annual return. At that rate, every $10,000 invested becomes more than $45,000 in just five years. Moreover, our maximum drawdown for the period is only 16.9%. While that's a bit steep for large cap stocks in a bull market, keep in mind that that the index of the 500 largest stocks printed a max drawdown of nearly 10% over the same period.
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Here are the top five stocks passed by the scan on a recent run (November 27, 2018), ranked in order from lowest to highest Price-to-Sales ratio:
Of these stocks, I especially like The Mosaic Company. The company is ranked a "strong buy" at Zacks Investment Research on the strength of improving earnings estimate revisions. The stock is well-loved by analysts and has received no less than 10 upgrades and raised price targets this year. And despite having a strong year (up 39.4% YTD), shares are still undervalued at just 1.5 times sales and 14.5 times forward earnings.
Editor's Note: Interested in learning more about Tom Carr's strategy for finding the best tech stocks the market has to offer? We're talking about little-known companies that are innovating and growing like crazy. And because they aren't your typical household names, they have the promise to deliver major gains once the crowd catches on. If you'd like to learn more about Extreme Tech Profits and what we're researching, contact our sales director Nate Equall toll-free at (888) 308-6247.