Often the real stock market winners are not the shares that look obviously cheap compared to book value or earnings but are instead the slightly more expensive high quality operators with improving outlooks.
ITV (LON:ITV) is one of them. Here's why this might be the case.
Top analysts and investors such as Warren Buffett and Michael Mauboussin say capital allocation - the deployment of company time, money, ideas, and people - is the key to building moat-like quality and profitability characteristics. It is perhaps the most fundamental driver of future share price performance. If you find a company that consistently allocates its capital profitably, chances are you are onto a long-term winner. I think ITV might be one such company.
Screening for upwardly mobile, high quality companies
If you’re only looking at sales and earnings growth, there is a vital question not being considered: how is this growth being funded?
That’s where ratios like return on equity (ROE) come in. ROE measures how efficiently a company uses Shareholders’ Equity to generate profits. It is calculated by dividing net income by book value of equity.
It’s no coincidence that Buffett is a fan of the measure - companies with high ROEs tend to exhibit the high-quality, moat-like business traits that he is so fond of gaining exposure to.
To find high ROE stocks whose fantastic business models are being rewarded by the market, you can create a screen that selects only stocks with both positive one-year relative strength and upgraded current year broker forecasts. The former ensures these shares have been outperforming the market and the latter suggests outperformance can continue.
One of the stocks that currently qualifies for this simple screen is ITV. The group has:
- A trailing twelve month return on equity of 60.1%
- An average current year EPS forecast upgrade of 2.13% from brokers, and
- A one-year relative strength of 4.26%
Stocks exhibiting these traits are typically a solid mix of quality and momentum. We can see this using the StockRanks: Itv has a Quality Rank of 69 and a Momentum Rank of 95.
Studies indicate that combining factors such as Value, Quality and Momentum is a more effective way of outperforming the market over longer time frames. That's why we have constructed our StockReports to give an instant impression of how well exposed Itv (LON:ITV) is to these three factors. We go into greater detail on factor investing in this video.
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