Idea of the Week: Bulls Versus Bears? Try Financial Stocks Vs Energy Producers for a Real Contrast

January 23rd, 2013 by

Historically, combing the StarMine Value-Momentum (Val-Mo) and the StarMine Earnings Quality (EQ) Models has generated significant investor outperformance. Using those two models to winnow through the U.S. market today shows that financial stocks appear to offer upside, while energy exploration and production companies may be in for a rougher ride.

Released: January 23 2013
Length: 3 Minutes

Everyone loves a stock that’s a winner, while some investors like to take a bit more risk by selling short those stocks that they expect to be losers. But how can you remain comfortable with your positions, whether long or short, while you’re waiting to see how those scenarios play out? Recently our colleague, Sridharan Raman, showed how combining two StarMine factors together generated dramatic outperformance. In a study, covering a 10-year period ended August 2012, Raman demonstrated that constructing a portfolio based on combining two StarMine models returned about 450% compared to a return of 109% on an equally weighted S&P 500 index.

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Let’s take a look at what this approach is saying about U.S. stocks in general, and about specific sectors, today.

Our original study demonstrated that using two StarMine models – the Valuation-Momentum Model (Val-Mo) and Earnings Quality Model (EQ) — together produced better returns than simply buying and holding a cross-section of stocks. Val-Mo, in turn, combines four StarMine models: two driven by momentum factors, the Analyst Revisions Model (ARM) and the Price Momentum (PM) Model, and another two that revolve around mean reversion, the StarMine Relative Valuation (RV) and Intrinsic Valuation (IV) Models. A company with a low Val-Mo score can prove to be a ‘value trap’, making this model useful in identifying stocks whose prices may be stuck in their current range for an extended period. The Earnings Quality model measures the degree to which investors can view past earnings as a reliable indicator of what the company will generate in terms of profits into the future. As is the case with all StarMine model scores, those companies with lower EQ scores are more likely to see their stocks lag those of their peers in the coming months.

The study applied the Val-Mo model to the universe of U.S.-listed stocks – those with a market capitalization north of $2 billion and that trade an average of at least 100,000 shares a day, thus making them investible – in search of companies scoring 80 or above for Val-Mo. To be added to the final list, the companies also had to score 70 or above on the Earnings Quality model, meaning that only the top 30% of candidates qualified.

The list of 39 companies produced using this approach is dominated by the Financials sector, which accounts for 19 of the names. Property and casualty insurance companies are the single largest group within Financials sector companies on the list, with five names, including Fidelity National Financial (FNF.N), which can boast a perfect ARM score of 100. Further reinforcing the evident affection for this company on the part of analysts is the fact that the company scores 83 out of a possible 100 today on the Recommendations Component portion of ARM model, even though as recently as December 17, 2012 it was a lowly 15.

Fidelity National Financial : ARM Component Scores

AllianceBernstein (AB.N) is another financials stock on the list that has been on a tear of late, having risen a remarkable 75% from its low of $11.44 last summer. The surge in the company’s stock in early January has put it into a price range where some investors may view it as overbought, at least on a technical basis, possibly keeping them from jumping in on the long side. But over the course of the last year, analysts have been raising their outlook for the company’s earnings, as reflected in the gold line in the chart below, on the right, while five of nine analysts with a rating on the stock have labeled it a Buy or Strong Buy, up from only 30 only 90 days ago.

Alliance Bernstein – StarMine Recommendations tab

Now let’s take a look at how we might set about using these models to identify candidates for stocks to be sold short, or to avoid owning. This involves using Val-Mo to identify companies that score 20 or less, and that have EQ scores of 30 or less. In this case, it is companies from the Thomson Reuters Energy sector that are the single largest grouping, making up 15 of the 54 companies on this second list. Of those, 11 are oil and gas exploration companies, while another three are coal-mining concerns. The Energy sector seems bifurcated, with the outlook for natural gas producers being gloomy in light of the fact that the commodity’s price has been hovering at remarkably low levels, while refining companies such as HollyFrontier Corp., (HFC.N) have been able to pay relatively low levels for feedstock and market the distillates they produce from them at much more attractive global prices. In light of the mood in Washington, the regulatory environment for coal companies is unlikely to become much easier any time soon.

While the fundamentals of these companies do look bearish, selling these stocks short may not be the best idea, as short sellers appear to have been there already. We looked at how StarMine’s Short Squeeze Indicator measure the likelihood of a relative price increase over the next 30 days for these energy stocks. In each case, the odds of such a short squeeze triggering a rally are moderate to high.

A case in point is SandRidge Energy (SD.N), an oil and gas producer in the midst of a battle between management and several large shareholders seeking, among other things, a shakeup of the company’s board. The company scores only 7 out of a possible 100 on the StarMine Short Interest Model, based on the attention the stock is getting from short sellers as a result of this conflict; these professional shorts get a company’s fundamentals more right than wrong, for the most part. However, the Short Squeeze indicator value (displayed above the blue histogram char, below) of 92 reflects the high likelihood that the shorts will end up being ‘squeezed’ by a sudden upward move in the price. A short squeeze is good if you own the stock, but can be very painful if you happen to have sold it short.

One company whose stock price seems to retain some modest downside potential in a period where shorts are being squeezed is natural gas exploration and production company WPX Energy (WPX.N). WPX scores a mere 1 out of a possible 100 on the ARM, and only 8 out of 100 on the StarMine SmartHoldings Model, signaling that there appears to be virtually no institutional appetite for the kind of characteristics it displays, as measured by the factors considered by the SmartHoldings Model. Thus, it may be possible that without a visible improvement in natural gas prices, WPX’s share price may continue to languish.

Sandridge Energy – StarMine Short Interest tab

As is the case with all StarMine screen results, the stocks on both of these lists should be carefully studied, in order to identify any other company-specific trends or industry issues that might affect your decision on whether or not you wish to own or short these stocks.

 
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