European value and momentum stocks inspired by Josef Lakonishok

Josef Lakonishok doesn’t really attract the same attention as many superstar investors but his successful transition from academic researcher to billion dollar fund manager is nonetheless legendary. Having spent 30 years studying investor behaviour and market anomalies, Lakonishok used his findings to devise a methodical way of finding attractively valued shares just at the point when the market is beginning to recognise them. Not only has the strategy been a strong performer in 2013, but the list of shares currently meeting Lakonishok’s rules in the UK and Europe offers a particularly wide range of options for investors.

Lakonishok has been a major contributor to research into behavioural finance and the ways in which markets and investors can sometimes act erratically. Influenced by Benjamin Graham’s value investing principles of buying unloved stocks at attractive prices, his work led him to conclude that investors are often too reliant on the past when predicting the future. He believes they frequently pay too much for good companies by ignoring fundamentals and becoming emotionally attached to them.

In response, he developed a strategy that blends two complementary investing approaches – value and momentum. He looks for shares that are cheap on any one of four common measures (price-to-book, price-to-earnings, price-to-cashflow or price-to-sales) but to avoid a so-called value trap, they also have to be rising in price. To find them, Lakonishok looks to see which of his cheap stocks have begun to see price strength over the previous six months – and whether this strength has sustained or even improved in the most recent three months. He also regards positive earnings surprises or upgraded recommendations by brokers as tell-tale signals that the share price could be on the move.

From theory to fortune

In 1994, Lakonishok and his academic partners started LSV Asset Management to put their finance theory into practice and its various funds now manage $69.7 billion of investor cash. In 2012, LSV’s Value Equity Fund produced a return of 20.3%. Its performance was dented by market conditions during 2007 and 2008 but the 10 year return remains a reasonable 7.7%. At Stockopedia we track a screen that uses all of these criteria and over the past 12 months it has returned an impressive 39%, beating the FTSE 100 by 22.3%. Over the past three months alone, the UK screen has returned 13.3%, whilst in Europe it has performed even better with a 16.4% return.

As Lakonishok’s approach is focused on relative, rather than absolute value, there are over 200 stocks across Europe that could be of interest to investors following this kind of strategy. Among several UK qualifiers is airline and logistics group Dart (LON:DTG), educational software company Tribal (LON:TRB) and rental equipment group Ashtead (LON:AHT) . All of them boast relative price strength against the market of more than 40% over the past six months but still look cheap on some measures.

Looking to Europe, the current qualifiers include Pelion (PEL), a Polish pharmaceuticals supplies and services business quoted on the Warsaw Stock Exchange with a market cap of £242 million. Its share price has more than doubled to PLN87.5 since late March but its forecast price-to-earnings ratio (PER) of 11.6x is well below the sector average of 15x. Last year was challenging for Pelion with net profits falling by 30% to PLN 55.9 million (£11.5 million) despite severe cost cutting as a result of demanding conditions. However, efforts to diversify from its core Polish and Lithuanian markets appear to be bearing fruit, with first quarter figures showing a marked improvement, with brokers upgrading their EPS forecasts as a result (see chart).

Elsewhere, and with a much larger market cap of £3.97bn, French automotive components manufacturer Valeo (FR) makes the list with six months relative strength of 38% and a forward PER of 10.3x. The catalyst for a recent rise in Valeo’s share price (see chart below) was a strong first quarter results statement in April in which it reported a 1.1% rise in sales to £3.04bn despite a dip in global automotive production. Exports to Germany, Asia and North America underpinned the group’s sales numbers and, after a rocky few years for the world automotive market, Valeo appears confident of growing this year.

Another company making the list is Swedish group Loomis (LOOM B), which runs a network of cash management and movement services across 16 countries. The £1bn market cap company has seen its shares rise by around 70% to SEK 147 over the past year and it trades on a forward PER of 14.7x. Loomis boasts a top scoring nine out of nine on the Piotroski F-Score of balance sheet health and last year delivered a strong set of results, including a record fourth quarter. Full year after-tax income grew by 26% to SEK 650 million (£64.5 million) as a result of efforts to boost efficiency and the effects of a recent acquisitive move in the US.

A blend of value and momentum

Lakonishok’s approach to investing leans on three decades of his own research that found that price and earnings momentum, in various guises, is a powerful enhancer to the returns of pure value for investors. Adding this element to the selection of cheap shares can help stock pickers to avoid value traps while potentially smoothing their returns. With value opportunities in certain parts of the UK market becoming increasingly difficult to find, taking this value and momentum strategy into Europe appears to offer a much broader range of options.

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