Recent Performance Anomolies

I was asked recently to explain more fully what caused the most recent performance anomalies of the Under- and Overvalued screens.

The chart below shows the performance of the Undervalued and Overvalued screens relative to our universe of approximately 500 equities. The Undervalued are comprised of the top quartile of both the Valuation Return (VR) and the Estimate/Normalized Earnings (EST/MPEPS or E/M).

(Click here to learn about valuation model and terms used)

Since inception in 2004, the Undervalued have outperformed the universe by 2.30 % points pa while the Overvalued under-performed by 3.23 % for a spread of 5.53% pa*.

However, there are three anomalous periods where investing in value bore a cost.  The first is the sub-par performance of the Undervalued from May 2008 to December 2008 (months 43 to 50). The second, also affecting the Undervalued, started in January 2012 and lasted until April 2013 (months 88 to 103).  Finally, the third anomaly is the superior performance of the Overvalued which took place between September 2011 and February 2014 (83-112).

The following is an analysis of the causes of the two most recent periods of sup-par performance.

Undervalued (88-103)

This table shows the undervalued stocks which were screened in months 88-103.  The column on the right shows the cumulative Relative Strength to the S&P that the individual stocks contributed over the 15 month period.  The worst 6 equities, 12% of the total number,  account for 84% of the decline of 18% relative.

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The column on the right above is shown in the graph below.  It illustrates that relatively few stocks accounted for the poor performance.  This is also shown by the median of all of the cumulative relative returns which is close to zero.

Looking at the performance by Sectors, Basic Materials is overweighted and is also had the worst performance.  Technology has an equal weighting but is also a major contributor.



Looking at the individual stocks, a common characteristic is the secular (vs cyclical) decline in the estimated earnings in the months following being screened.  Where this occurs, it shows up as a decline of  the normalized earnings (MPEPS - red line).  The following individual equity graphs show the Estimated earnings (EST), normalized earnings (MPEPS) and the implied earnings (IEPS).  The green  bars indicate the months that the equity was screened.

CAT is an exception in that there is little decline in the normalized earnings suggesting the decline in estimates was more cyclical.  The majority suffered a secular decline in earnings.

Overvalued (83-112)

The superior performance of the Overvalued screens in months 83-112 somewhat overlaps but has a substantial positive median return.  Here the median  cumulative Relative Strength of all stocks screened is  +5.7%, or an average of 0.74% per month.

The top and bottom screened equities by total Relative Strength are shown here (the file below is complete)

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Sector weighting and performance is shown here and it is clear that Consumer Cyclicals had a lot to do with the positive performance of the Overvalued screens.  They had twice the weighting and strongly positive relative strength.

As it turns out, there was (and is) a huge bet on Home Building and Building Supplies.

Examples of the top contributors are:

KBH's estimates do rise to the level of Implied Earnings.  This is the only one  where the earnings estimates rose to the level of implied earnings when screened although normalized earnings remains well below implied.

LEN has rising earnings estimates but implied earnings remain well above.

In this instance, the majority of these stocks benefited from expectations that failed to materialize, some of which persists to the present.


* The Universe did 2.18% pa better than the S&P 500, very similar to an unweighted S&P 500 return.